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Questions and Answers of Corporate Finance

What is the difference between spot rates and forward rates? When is the forward rate at a premium to the spot rate? At a discount?
What is interest rate parity? Currently, you can exchange 1 euro for 1.2700 dollars in the 180-day forward market, and the risk-free rate on 180-day securities is 6 percent in the United States and 4
What is purchasing power parity? If grapefruit juice costs $2.00 a liter in the United States and purchasing power parity holds, what should be the price of grapefruit juice in Spain?
What impact does relative inflation have on interest rates and exchange rates?
Briefly discuss the international capital markets.
To what extent do average capital structures vary across different countries?
Briefly describe special problems that occur in multinational capital budgeting and describe the process for evaluating a foreign project. Now consider the following project. A U.S. company has the
Define the following terms, using graphs or equations to illustrate your answers where feasible.a. Risk in general; stand-alone risk; probability distribution and its relation to riskb. Expected rate
The probability distribution of a less risky return is more peaked than that of a riskier return. What shape would the probability distribution have for? (a) Completely certain returns and (b)
Security A has an expected return of 7%, a standard deviation of returns of 35%, a correlation coefficient with the market of −0.3, and a beta coefficient of −1.5. Security B has an expected
Suppose you owned a portfolio consisting of $250,000 of U.S. government bonds with a maturity of 30 years.a. Would your portfolio be riskless?b. Now suppose you hold a portfolio consisting of
If investors’ aversion to risk increased, would the risk premium on a high-beta stock increase by more or less than that on a low-beta stock? Explain.
If a company’s beta were to double, would its expected return double?
In the real world, is it possible to construct a portfolio of stocks that has an expected return equal to the risk-free rate?
An individual has $35,000 invested in a stock with a beta of 0.8 and another $40,000 invested in a stock with a beta of 1.4. If these are the only two investments in her portfolio, what is her
Assume that the risk-free rate is 6% and that the expected return on the market is 13%. What is the required rate of return on a stock that has a beta of 0.7?
Assume that the risk-free rate is 5% and that the market risk premium is 6%. What is the required return on the market, on a stock with a beta of 1.0, and on a stock with a beta of 1.2?
A stock's return has the following distribution Calculate the stock's expected return, standard deviation, and coefficient of variation.
The market and Stock J have the following probability distributions: a. Calculate the expected rates of return for the market and Stock J.b. Calculate the standard deviations for the market and
Suppose rRF = 5%, rM = 10%, and rA = 12%.a. Calculate Stock A’s beta.b. If Stock A’s beta were 2.0, then what would be A’s new required rate of return?
Suppose rRF = 9%, rM = 14%, and bi = 1.3.a. What is ri, the required rate of return on Stock i?b. Now suppose rRF (1) increases to 10% or (2) decreases to 8%. The slope of the SML remains constant.
Suppose you hold a diversified portfolio consisting of a $7,500 investment in each of 20 different common stocks. The portfolio’s beta is 1.12. Now, suppose you sell one of the stocks with a beta
Suppose you manage a $4 million fund that consists of four stocks with the following investments: If the market's required rate of return is 14% and the risk-free rate is 6%, what is the fund's
You have a $2 million portfolio consisting of a $100,000 investment in each of 20 different stocks. The portfolio has a beta of 1.1. You are considering selling $100,000 worth of one stock with a
Stock R has a beta of 1.5, Stock S has a beta of 0.75, the expected rate of return on an average stock is 13%, and the risk-free rate is 7%. By how much does the required return on the riskier stock
Stocks A and B have the following historical returns: a. Calculate the average rate of return for each stock during the 5-year period.b. Assume that someone held a portfolio consisting of 50% of
You have observed the following returns over time: Assume that the risk-free rate is 6% and the market risk premium is 5%. a. What are the betas of Stocks X and Y? b. What are the required rates of
What are investment returns? What is the return on an investment that costs $1,000 and is sold after one year for $1,100?
Why is the t-bill’s return independent of the state of the economy? Do t-bills promise a completely risk-free return?
Why are Alta Ind.’s returns expected to move with the economy whereas Repo Men’s are expected to move counter to the economy?
Calculate the expected rate of return on each alternative and fill in the blanks on the row for r in the table.
You should recognize that basing a decision solely on expected returns is appropriate only for risk-neutral individuals. Because your client, like virtually everyone, is risk averse, the riskiness of
What type of risk is measured by the standard deviation?
Draw a graph that shows roughly the shape of the probability distributions for Alta Industries, American Foam, and T-bills.
Suppose you suddenly remembered that the coefficient of variation (CV) is generally regarded as being a better measure of stand-alone risk than the standard deviation when the alternatives being
Suppose you created a 2-stock portfolio by investing $50,000 in Alta Industries and $50,000 in Repo Men.Calculate the expected return (pr), the standard deviation (σp), and the coefficient of
How does the risk of this 2-stock portfolio compare with the risk of the individual stocks if they were held in isolation?
Suppose an investor starts with a portfolio consisting of one randomly selected stock. What would happen (1) to the risk and (2) to the expected return of the portfolio as more and more randomly
Should portfolio effects impact the way investors think about the risk of individual stocks?
If you decided to hold a 1-stock portfolio, and consequently were exposed to more risk than diversified investors, could you expect to be compensated for all of your risk; that is, could you earn a
How is market risk measured for individual securities? How are beta coefficients calculated?
Suppose you have the following historical returns for the stock market and for another company, P.Q. Unlimited. Explain how to calculate beta, and use the historical stock returns to calculate the
Do the expected returns appear to be related to each alternative’s market risk? (2) Is it possible to choose among the alternatives on the basis of the information developed thus far?
Write out the Security Market Line (SML) equation, use it to calculate the required rate of return on each alternative, and then graph the relationship between the expected and required rates of
How do the expected rates of return compare with the required rates of return?
Does the fact that Repo Men has an expected return that is less than the T-bill rate make any sense?
What would be the market risk and the required return of a 50-50 portfolio of Alta Industries and Repo Men? Of Alta Industries and American Foam?
Suppose investors raised their inflation expectations by 3 percentage points over current estimates as reflected in the 8 percent T-bill rate. What effect would higher inflation have on the SML and
Suppose instead that investors’ risk aversion increased enough to cause the market risk premium to increase by 3 percentage points. (Inflation remains constant.) What effect would this have on the
Define each of the following terms:a. Proxy; proxy fight; takeover; preemptive right; classified stock; founders’ sharesb. Closely held stock; publicly owned stockc. Intrinsic value (P0); market
Two investors are evaluating General Electric’s stock for possible purchase. They agree on the expected value of D1 and also on the expected future dividend growth rate. Further, they agree on the
A bond that pays interest forever and has no maturity date is a perpetual bond, also called a perpetuity or a consol. In what respect is a perpetual bond similar to (1) a nogrowth common stock and
In this chapter and elsewhere we have argued that a stock’s market price can deviate from its intrinsic value. Discuss the following question: If all investors attempt to behave in an entirely
Thress Industries just paid a dividend of $1.50 a share (i.e., D0 = $1.50). The dividend is expected to grow 5% a year for the next 3 years and then 10% a year thereafter. What is the expected
Boehm Incorporated is expected to pay a $1.50 per share dividend at the end of this year (i.e., D1 = $1.50). The dividend is expected to grow at a constant rate of 7% a year. The required rate of
Woidtke Manufacturing’s stock currently sells for $20 a share. The stock just paid a dividend of $1.00 a share (i.e., D0 = $1.00), and the dividend is expected to grow forever at a constant rate of
Nick’s Enchiladas Incorporated has preferred stock outstanding that pays a dividend of $5 at the end of each year. The preferred sells for $50 a share. What is the stock’s required rate of return?
A company currently pays a dividend of $2 per share (D0 = $2). It is estimated that the company’s dividend will grow at a rate of 20% per year for the next 2 years, then at a constant rate of 7%
A stock is trading at $80 per share. The stock is expected to have a year-end dividend of $4 per share (D1 = $4), and it is expected to grow at some constant rate g throughout time. The stock’s
You are considering an investment in Crisp Cookware’s common stock. The stock is expected to pay a dividend of $2 a share at the end of this year (D1 = $2.00); its beta is 0.9; the risk-free rate
What is the nominal rate of return on a preferred stock with a $100 par value, a stated dividend of 8% of par, and a current market price of (a) $60, (b) $80,(c) $100, and (d) $140?
Brushy Mountain Mining Company’s ore reserves are being depleted, so its sales are falling. Also, its pit is getting deeper each year, so its costs are rising. As a result, the company’s earnings
The beta coefficient for Stock C is bC = 0.4 and that for Stock D is bD = −0.5. (Stock D’s beta is negative, indicating that its rate of return rises whenever returns on most other stocks fall.
Assume that the average firm in your company’s industry is expected to grow at a constant rate of 6% and that its dividend yield is 7%. Your company is about as risky as the average firm in the
Simpkins Corporation is expanding rapidly, and it does not pay any dividends because it currently needs to retain all of its earnings. However, investors expect Simpkins to begin paying dividends,
Several years ago, Rolen Riders issued preferred stock with a stated annual dividend of 10% of its $100 par value. Preferred stock of this type currently yields 8%. Assume dividends are paid
You buy a share of The Ludwig Corporation stock for $21.40. You expect it to pay dividends of $1.07, $1.1449, and $1.2250 in Years 1, 2, and 3, respectively, and you expect to sell it at a price of
Investors require a 15% rate of return on Brooks Sisters’s stock (rs = 15%).a. What would the value of Brooks’s stock be if the previous dividend was D0 = $2 and if investors expect dividends to
The risk-free rate of return, rRF, is 11%; the required rate of return on the market, rM, is 14%; and Schuler Company’s stock has a beta coefficient of 1.5.a. If the dividend expected during the
Suppose a firm’s common stock paid a dividend of $2 yesterday. You expect the dividend to grow at the rate of 5% per year for the next 3 years; if you buy the stock, you plan to hold it for 3 years
Reizenstein Technologies (RT) has just developed a solar panel capable of generating 200% more electricity than any solar panel currently on the market. As a result, RT is expected to experience a
Taussig Technologies Corporation (TTC) has been growing at a rate of 20% per year in recent years. This same supernormal growth rate is expected to last for another 2 years (g1 = g2 = 20%).a. If D0 =
Describe briefly the legal rights and privileges of common stockholders.
Write out a formula that can be used to value any stock, regardless of its dividend pattern.
What is a constant growth stock? How are constant growth stocks valued?
What happens if a company has a constant g that exceeds its rs? Will many stocks have expected g > rs in the short run (i.e., for the next few years)? In the long run (i.e., forever)?
Assume that Temp Force has a beta coefficient of 1.2, that the risk-free rate (the yield on T-bonds) is 7%, and that the market risk premium is 5%. What is the required rate of return on the
Assume that Temp Force is a constant growth company whose last dividend (D0, which was paid yesterday) was $2.00 and whose dividend is expected to grow indefinitely at a 6%rate.What is the firm’s
What is the firm’s current stock price?
What is the stock’s expected value one year from now?
What are the expected dividend yield, the capital gains yield, and the total return during the first year?
Now assume that the stock is currently selling at $30.29. Compute its expected rate of return?
What would the stock price be if its dividends were expected to have zero growth?
Now assume that Temp Force’s dividend is expected to experience super normal growth of 30% from Year 0 to Year 1, 20% from Year 1 to Year 2, and 10% from Year 2 to Year 3. After Year 3, dividends
Now assume that Temp Force’s dividend is expected to experience supernormal growth of 30% from Year 0 to Year 1, 20% from Year 1 to Year 2, and 10% from Year 2 to Year 3. After Year 3, dividends
Is the stock price based more on long-term or short-term expectations? Answer this by finding the percentage of Temp Force’s current stock price based on dividends expected more than three years in
Suppose Temp Force is expected to experience zero growth during the first 3 years and then to resume its steady-state growth of 6% in the fourth year. What is the stock’s value now? What is its
Finally, assume that Temp Force’s earnings and dividends are expected to decline by a constant 6% per year forever, that is, g = −6%. Why would anyone be willing to buy such a stock, and at what
What is market mutliple analysis?
Why do stock prices change? Suppose the expected D1 is $2, the growth rate is 5%, and rs is 10%. Using the constant growth model, what is the stock’s price? What is the impact on the stock price if
What does market equilibrium mean?
Temp Force recently issued preferred stock that pays an annual dividend of $5 at a price of $50 per share. What is the expected return to an investor who buys this preferred stock?
What is the Efficient Markets Yypothesis, what are its three forms, and what are its implications?
Assume that all the growth rates used in the preceding answers were averages of the growth rates published by well known and respected security analysts. This being the case, would you say that your
Define each of the following terms:a. Proprietorship; partnership; corporationb. Limited partnership; limited liability partnership; Professional Corporationc. Stockholder wealth maximizationd. Money
What are the three principal forms of business organization? What are the advantages and disadvantages of each?
What is a firm’s fundamental, or intrinsic, value? What might cause a firm’s intrinsic value to be different than its actual market value?
Edmund Enterprises recently made a large investment to upgrade its technology. Although these improvements won’t have much of an impact on performance in the short run, they are expected to reduce
Describe the different ways in which capital can be transferred from suppliers of capital to those who are demanding capital.
What are financial intermediaries, and what economic functions do they perform?

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