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Questions and Answers of
Corporate Finance
In the previous problem, suppose you think it is likely that expected sales will be revised upwards to 17,000 units if the first year is a success and revised downward to 3,400 units if the first
In the previous problem, suppose the scale of the project can be doubled in one year in the sense that twice as many units can be produced and sold. Naturally, expansion would only be desirable if
In the previous problem, suppose the projections given for price, quantity, variable costs, and fixed costs are all accurate to within ±10 percent. Calculate the best-case and worst-case NPV figures.
Samuelson, Inc., has just purchased a $675,000 machine to produce calculators. The machine will be fully depreciated by the straight-line method over its economic life of five years and will produce
Tidwell Products, Inc., is considering a new product launch. The firm expects to have an annual operating cash flow of $13 million for the next 10 years. Tidwell Products uses a discount rate of 14
You are the financial analyst for a tennis racket manufacturer. The company is considering using a graphite-like material in its tennis rackets. The company has estimated the information in the table
Consider a project to supply Detroit with 60,000 tons of machine screws annually for automobile production. You will need an initial $3,250,000 investment in threading equipment to get the project
In Problem 26, suppose you’re confident about your own projections, but you’re a little unsure about Detroit’s actual machine screw requirement. What is the sensitivity of the project OCF to
Consider the following project for Hand Clapper, Inc. The company is considering a four-year project to manufacture clap-command garage door openers. This project requires an initial investment of
In each of the following cases, find the unknown variable. Ignore taxes.
Shane's Toys Inc. just purchased a $325,000 machine to produce toy cars. The machine will be fully depreciated by the straight-line method over its five-year economic life. Each toy sells for $32.
Your company is deciding whether to invest in a new machine. The new machine will increase cash flow by $425,000 per year. You believe the technology used in the machine has a 10-year life; in other
Ang Electronics, Inc., has developed a new HD DVD. If the HD DVD is successful, the present value of the payoff (at the time the product is brought to market) is $30 million. If the HD DVD fails, the
The manager for a growing firm is considering the launch of a new product. If the product goes directly to market, there is a 40 percent chance of success. For $85,000, the manager can conduct a
You are considering investing in a company that cultivates abalone for sale to local restaurants. Use the following information:The discount rate for the company is 13 percent, the initial
In Problem 9, suppose the average inflation rate over this period was 2.8 percent and the average T-bill rate over the period was 3.6 percent. a. What was the average real return on Yasmin’s
A stock has had returns of –17.62 percent, 15.38 percent, 10.95 percent, 26.83 percent, and 5.31 percent over the past five years, respectively. What was the holding period return for the stock?
Refer to Table 10.1 . What was the average real return for Treasury bills from 1926 through 1932?Table 10.1
Refer back to Table 10.2 . What range of returns would you expect to see 68 percent of the time for long-term corporate bonds? What about 95 percent of the time?Table 10.2
Refer back to Table 10.2 . What range of returns would you expect to see 68 percent of the time for large-company stocks? What about 95 percent of the time?Table 10.2
You find a certain stock that had returns of 14 percent, 8 percent, –17 percent, and 19 percent for four of the last five years. If the average return of the stock over this period was 10.35
A stock has had returns of –17 percent, 42 percent, 31 percent, –24 percent, 17 percent, and 21 percent over the last six years. What are the arithmetic and geometric returns for the stock?
A stock has had the following year-end prices and dividends:What are the arithmetic and geometric returns for the stock?
Refer to Table 10.1 in the text and look at the period from 1973 through 1980.a. Calculate the average return for Treasury bills and the average annual inflation rate (consumer price index) for this
In the previous problem, what is the probability that the return is less than –100 percent? (Think.) What are the implications for the distribution of returns?
Suppose you bought a 7.5 percent coupon bond one year ago for $1,030. The bond sells for $970 today. a. Assuming a $1,000 face value, what was your total dollar return on this investment over the
Using the following returns, calculate the average returns, the variances, and the standard deviations for X and Y.
Refer to Table 10.1 in the text and look at the period from 1973 through 1978.a. Calculate the arithmetic average returns for large-company stocks and T-bills over this time period.b. Calculate the
You’ve observed the following returns on Yasmin Corporation’s stock over the past five years: 19 percent, – 13 percent, 24 percent, 31 percent, and 8 percent. a. What was the arithmetic average
Is the following statement true of false? A risky security cannot have an expected return that is less than the risk-free rate because no risk-averse investor would be willing to hold this asset in
You own a stock portfolio invested 15 percent in Stock Q, 20 percent in Stock R, 30 percent in Stock S, and 35 percent in Stock T. The betas for these four stocks are .85, 1.65, 1.10, and 1.26,
A stock has a beta of 1.25, the expected return on the market is 11.5 percent, and the risk-free rate is 3.4 percent. What must the expected return on this stock be?
A stock has a beta of 1.15 and an expected return of 14 percent. A risk-free asset currently earns 4.2 percent. a. What is the expected return on a portfolio that is equally invested in the two
Stock Y has a beta of 1.35 and an expected return of 14.2 percent. Stock Z has a beta of .75 and an expected return of 9.1 percent. If the risk-free rate is 4.3 percent and the market risk premium
In the previous problem, what would the risk-free rate have to be for the two stocks to be correctly priced?
Consider the following information on three stocks:a. If your portfolio is invested 30 percent each in A and B and 40 percent in C, what is the portfolio expected return? The variance? The standard
You want to create a portfolio equally as risky as the market, and you have $1,000,000 to invest. Given this information, fill in the rest of the following table:
Based on the following information, calculate the expected return and standard deviation of each of the following stocks. Assume each state of the economy is equally likely to happen. What is the
Based on the following information, calculate the expected return and standard deviation for each of the following stocks. What is the covariance and correlation between the returns of the two
Suppose the expected returns and standard deviations of stocks A and B are E( R A ) = .11, E( R B ) = .14, σA = .52, and σB = .65, respectively. a. Calculate the expected return and standard
You have been provided the following data on the securities of three firms, the market portfolio, and the risk-free asset:*With the market portfolio. a. Fill in the missing values in the table. b. Is
You own a portfolio that is 45 percent invested in Stock X, 30 percent invested in Stock Y, and 25 percent invested in Stock Z. The expected returns on these three stocks are 10 percent, 13 percent,
Suppose the risk-free rate is 3.9 percent and the market portfolio has an expected return of 11.2 percent. The market portfolio has a variance of .0460. Portfolio Z has a correlation coefficient
Consider the following information on Stocks I and II:The market risk premium is 7.5 percent, and the risk-free rate is 4 percent. Which stock has the most systematic risk? Which one has the most
Suppose you observe the following situation:Assume these securities are correctly priced. Based on the CAPM, what is the expected return on the market? What is the risk-free rate?
There are three securities in the market. The following chart shows their possible payoffs.a. What is the expected return and standard deviation of each security? b. What are the covariances and
Suppose you observe the following situation:a. Calculate the expected return on each stock. b. Assuming the capital asset pricing model holds and stock As beta is greater than stock
There are two stocks in the market: stock A and stock B. The price of stock A today is $52. The price of stock A next year will be $40 if the economy is in a recession, $59 if the economy is normal,
Assume stocks A and B have the following characteristics:The covariance between the returns on the two stocks is .01. a. Suppose an investor holds a portfolio consisting of only stock A and stock B.
Based on the following information, calculate the expected return.
Based on the following information, calculate the expected return and standard deviation for the two stocks.
Based on the following information, calculate the expected return and standard deviation of the following stock.
A portfolio is invested 25 percent in Stock G, 60 percent in Stock J, and 15 percent in Stock K. The expected returns on these stocks are 10 percent, 12 percent, and 19 percent, respectively. What is
Consider the following information:a. Your portfolio is invested 40 percent each in A and C, and 20 percent in B. What is the expected return of the portfolio?b. What is the variance of this
Filer Manufacturing has 7.5 million shares of common stock outstanding. The current share price is $49, and the book value per share is $4. Filer Manufacturing also has two bond issues outstanding.
In the previous problem, suppose the company’s stock has a beta of 1.2. The risk-free rate is 5.2 percent, and the market risk premium is 7 percent. Assume that the overall cost of debt is the
Kose, Inc., has a target debt-equity ratio of .65. Its WACC is 11.2 percent, and the tax rate is 35 percent. a. If Kose’s cost of equity is 15 percent, what is its pretax cost of debt? b. If
An all-equity firm is considering the following projects:The T-bill rate is 5 percent, and the expected return on the market is 11 percent. a. Which projects have a higher expected return than the
Floyd Industries stock has a beta of 1.50. The company just paid a dividend of $.80, and the dividends are expected to grow at 5 percent per year. The expected return on the market is 12 percent,
This is a comprehensive project evaluation problem bringing together much of what you have learned in this and previous chapters. Suppose you have been hired as a financial consultant to Defense
Miller Manufacturing has a target debt-equity ratio of .45. Its cost of equity is 17 percent, and its cost of debt is 10 percent. If the tax rate is 35 percent, what is Miller’s WACC?
1. What would a technical analyst say about market efficiency?2. A technical analysis tool that is sometimes used to predict market movements is an investor sentiment index. AAII, the American
In a world with no taxes, no transaction costs, and no costs of financial distress, is the following statement true, false, or uncertain? If a firm issues equity to repurchase some of its debt, the
Beckett, Inc., has no debt outstanding and a total market value of $250,000. Earnings before interest and taxes, EBIT, are projected to be $13,000 if economic conditions are normal. If there is
Cede & Co. expects its EBIT to be $57,500 every year forever. The firm can borrow at 8 percent. Cede currently has no debt, and its cost of equity is 15 percent. If the tax rate is 35 percent, what
Levered, Inc., and Unlevered, Inc., are identical in every way except their capital structures. Each company expects to earn $275,000 before interest per year in perpetuity, with each company
Tool Manufacturing has an expected EBIT of $24,000 in perpetuity and a tax rate of 35 percent. The firm has $65,000 in outstanding debt at an interest rate of 8.5 percent, and its unlevered cost of
Young Corporation expects an EBIT of $19,750 every year forever. The company currently has no debt, and its cost of equity is 15 percent. a. What is the current value of the company? b. Suppose the
Repeat parts (a) and (b) in Problem 1 assuming Beckett has a tax rate of 35 percent.In problema. Calculate earnings per share, EPS, under each of the three economic scenarios before any debt is
The Veblen Company and the Knight Company are identical in every respect except that Veblen is not levered. The Knight Companys 6 percent bonds sell at par value. Financial information
Garnett Corporation is planning to repurchase part of its common stock by issuing corporate debt. As a result, the firm’s debt-to-equity ratio is expected to rise from 30 percent to 45 percent.
Williamson, Inc., has a debt-to-equity ratio of 2.2. The firm’s weighted average cost of capital is 10 percent, and its pretax cost of debt is 6 percent. Williamson is subject to a corporate
In a world of corporate taxes only, show that the RWACC can be written as RWACC = R0 × [1 – tC ( B/V)].
Assume a firm’s debt is risk-free, so that the cost of debt equals the risk-free rate, Rf . Define βA as the firm’s asset beta, that is, the systematic risk of the firm’s assets. Define βS
Suppose the company in Problem 1 has a market-to-book ratio of 1.0. a. Calculate return on equity, ROE, under each of the three economic scenarios before any debt is issued. Also, calculate the
Beginning with the cost of capital equation, that is:Show that the cost of equity capital for a levered firm can be written as:
Yasmin Corporation is comparing two different capital structures, an all- equity plan (Plan I) and a levered plan (Plan II). Under Plan I, Yasmin would have 170,000 shares of stock outstanding. Under
In Problem 4, use MM Proposition I to find the price per share of equity under each of the two proposed plans. What is the value of the firm? In problem Yasmin Corporation is comparing two different
Sanborn Corp. is comparing two different capital structures. Plan I would result in 2,300 shares of stock and $22,560 in debt. Plan II would result in 1,400 shares of stock and $47,940 in debt. The
Ignoring taxes in Problem 6, what is the price per share of equity under Plan I? Plan II? What principle is illustrated by your answers? In problem a. Ignoring taxes, compare both of these plans to
Conspicuous Consumption, Inc., a prominent consumer products firm, is debating whether or not to convert its all-equity capital structure to one that is 35 percent debt. Currently, there are 8,000
ABC Co. and XYZ Co. are identical firms in all respects except for their capital structures. ABC is all-equity financed with $500,000 in stock. XYZ uses both stock and perpetual debt; its stock is
What are the sources of the agency costs of equity?
Refer to the observed capital structures given in Table 15.3 of the text. What do you notice about the types of industries with respect to their average debt-equity ratios? Are certain types of
Maslyn Corp. has an EBIT of $740,000 per year that is expected to continue in perpetuity. The unlevered cost of equity for the company is 14 percent, and the corporate tax rate is 35 percent. The
Dragula, Inc., has debt outstanding with a face value of $3.8 million. The value of the firm if it were entirely financed by equity would be $12.3 million. The company also has 245,000 shares of
Suppose the president of the company in the previous problem stated that the company should increase the amount of debt in its capital structure because of the tax-advantaged status of its interest
Sheaves Corporation economists estimate that a good business environment and a bad business environment are equally likely for the coming year. The managers of Sheaves must choose between two
How does the life cycle of a company help explain dividend payments? What evidence is there to suggest that the company’s life cycle, at least in part, explains dividend payments?
Since it can be shown that share repurchases have exactly the same wealth effect for shareholders in the absence of taxes and are more beneficial when we account for taxes, why don’t all companies
For initial public offerings of common stock, 2009 was a slow year, with over $13 billion raised by the process. Relatively few of the 41 firms involved paid cash dividends. Why do you think that
Midnight Hour Inc., has declared a $5.10 per-share dividend. Suppose capital gains are not taxed, but dividends are taxed at 15 percent. New IRS regulations require that taxes be withheld at the time
The Mann Company currently has 95,000 outstanding shares selling at $96 each. The firm is contemplating the declaration of a $5 dividend at the end of the fiscal year that just began. Assume there
The net income of Novis Corporation is $90,000. The company has 35,000 outstanding shares, and a 100 percent payout policy. The expected value of the firm one year from now is $1,650,000. The
The Gecko Company and the Gordon Company are two firms whose business risk is the same but that have different dividend policies. Gecko pays no dividend, whereas Gordon has an expected dividend yield
As discussed in the text, in the absence of market imperfections and tax effects, we would expect the share price to decline by the amount of the dividend payment when the stock goes ex dividend.
The owners’ equity accounts for Octagon International are shown here: Common stock ($1 par value) .......... $25,000 Capital surplus ................... 195,000 Retained earnings
After completing its capital spending for the year, Carlson Manufacturing has $1,000 extra cash. Carlson’s managers must choose between investing the cash in Treasury bonds that yield 3.5 percent
For the company in Problem 2, show how the equity accounts will change if: a. Octagon declares a four-for-one stock split. How many shares are outstanding now? What is the new par value per
The balance sheet for Levy Corp. is shown here in market value terms. There are 8,000 shares of stock outstanding.The company has declared a dividend of $1.30 per share. The stock goes ex-dividend
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