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Questions and Answers of
Corporate Finance
A precision lathe costs $10,000 and will cost $20,000 a year to operate and maintain. If the discount rate is 10% and the lathe will last for 5 years, what is the equivalent annual cost of the tool?
A firm can lease a truck for 4 years at a cost of $30,000 annually. It can instead buy a truck at a cost of $80,000, with annual maintenance expenses of $10,000. The truck will be sold at the end of
Which project would you choose if the opportunity cost of capital were 16%?
You can purchase an optical scanner today for $400. The scanner provides benefits worth $60 a year. The expected life of the scanner is 10 years. Scanners are expected to decrease in price by 20% per
A forklift will last for only 2 more years. It costs $5,000 a year to maintain. For $20,000 you can buy a new lift that can last for 10 years and should require maintenance costs of only $2,000 a
Growth Enterprises believes its latest project, which will cost $80,000 to install, will generate a perpetual growing stream of cash flows. Cash flow at the end of the first year will be $5,000, and
Strip Mining Inc. can develop a new mine at an initial cost of $5 million. The mine will provide a cash flow of $30 million in 1 year. The land then must be reclaimed at a cost of $28 million in the
A new furnace for your small factory will cost $27,000 a year to install and will require ongoing maintenance expenditures of $1,500 a year. But it is far more fuel- efficient than your old furnace
A classic problem in management of forests is determining when it is most economically advantageous to cut a tree for lumber. When the tree is young, it grows very rapidly. As it ages, its growth
In light of your answers to Problems 2-4, is there any reason to believe that the project with the higher IRR is the better project?
If the opportunity cost of capital is 11 %, what is the profitability index for each project? Is the project with the highest profitability index also the one with the highest NPV? Which criterion
Is the project with the shortest payback period also the one with the highest NPV? Which criterion should you use?
A project that costs $3,000 to install will provide annual cash flows of $800 for each of the next 6 years. What is NPV if the discount rate is 10%? Is this project worth pursuing? How high can the
Quick Computing currently sells 10 million computer chips each year at a price of $20 per chip. It is about to introduce a new chip, and it forecasts annual sales of 12 million of these improved
Revenues generated by a new fad product are forecast as
Blooper Industries must replace its magnoosium purification system. Quick & Dirty Systems sells a relatively cheap purification system for $10 million. The system will last 5 years. Do-It-Right sells
We've emphasized that the firm should pay attention only to cash flows when assessing the net present value of proposed projects. Depreciation is a noncash expense. Why then does it matter whether we
Your firm purchased machinery with a 7-year MACRS life for $10 million. The project, however, will end after 5 years. If the equipment can be sold for $4.5 million at the completion of the project,
Bottoms Up Diaper Service is considering the purchase of a new industrial washer. It can purchase the washer for $6,000 and sell its old washer for $2,000. The new washer will last for 6 years and
Match each of the following terms to one of the definitions or descriptions listed below: sensitivity analysis, scenario analysis, break-even analysis, operating leverage, decision tree, real
The following estimates have been prepared for a project: Fixed costs: $20,000Depreciation: $10,000 Sales price: $2Accounting break-even: 60,000 unitsWhat must be the variable cost per unit?
Dime a Dozen Diamonds makes synthetic diamonds by treating carbon. Each diamond can be sold for $ 100. The materials cost for a standard diamond is $40. The fixed costs incurred each year for factory
You are evaluating a project that will require an investment of $10 million that will be depreciated over a period of 7 years. You are concerned that the corporate tax rate will increase during the
Define the cash-flow break-even point as the sales volume (in dollars) at which cash flow equals zero. a. Is the cash-flow break-even level of sales higher or lower than the zero-profit (accounting)
Modern Artifacts can produce keepsakes that will be sold for $80 each. Nondepreciation fixed costs are $1,000 per year, and variable costs are $60 per unit. The initial investment of $3,000 will be
A financial analyst has computed both accounting and NPV breakeven sales levels for a project using straight-line depreciation over a 6-year period. The project manager wants to know what will happen
Reconsider Fine fodder's new superstore. Suppose that by investing an additional $600,000 initially in more efficient checkout equipment, Fine fodder could reduce variable costs to 80% of sales.a.
You estimate that your cattle farm will generate $ 1 million of profits on sales of $4 million under normal economic conditions and that the degree of operating leverage is 8.a. What will profits be
a. What is the degree of operating leverage of Modern Artifacts (in Problem 14) when sales are $7,000?b. What is the degree of operating leverage when sales are $12,000?c. Why is operating leverage
a. Approval of the capital budget allows manager to go ahead with any project included in the budget. b. Project authorizations are mostly developed "bottom-up." Strategic planning is a "top-down"
a. Approval of the capital budget allows manager to go ahead with any project included in the budget. b. Project authorizations are mostly developed "bottom-up." Strategic planning is a "top-down"
What is the lowest possible value for the degree of operating leverage for a profitable firm? Show with a numerical example that if Modern Artifacts (see Problem 14) has zero fixed costs, then DOL =
A project has fixed costs of $ 1,000 per year, depreciation charges of $500 a year, annual revenue of $6,000, and variable costs equal to two-thirds of revenues.a. If sales increase by 10%, what will
Section 10.4 describes four types of real option. For each of the following cases state which type of option is involved: a. Deutsche Metall postpones a major plant expansion. The expansion has a
Your midrange guess as to the amount of oil in a prospective field is 10 million barrels, but in fact there is a 50% chance that the amount of oil is 15 million barrels and a 50% chance of 5 million
A silver mine can yield 10,000 ounces of silver at a variable cost of $32 per ounce. The fixed costs of operating the mine are $40,000 per year. In half the years, silver can be sold for $48 per
Explain why options to expand or contract production are most valuable when forecasts about future business conditions are most uncertain.
The box on page 314 describes Singapore Airlines option to buy additional A350 airliners. Draw a decision tree showing the future choices faced by the airline.
New Energy is evaluating a new biofuel facility. The plant would cost $4,000 million to build and has the potential to produce up to 40 million barrels of synthetic oil a year. The product is a close
True or false? a. Sensitivity analysis can be used to identify the variables most crucial to a project's success. b. Sensitivity analysis is used to obtain expected, optimistic, and pessimistic
In a slow year, Deutsche Burgers will produce 2 million hamburgers at a total cost of $3.5 million. In a good year, it can produce 4 million hamburgers at a total cost of $4.5 million. a. What are
A project currently generates sales of $10 million, variable costs equal 50% of sales, and fixed costs are $2 million. The firm's tax rate is 35%. What are the effects of the following changes on
Finefodder's analysts have come up with the following revised estimates for the Gravenstein store (Section 10.2):Conduct a sensitivity analysis using the revised data. Label yours answer as follows:
Emperor's Clothes Fashions can invest $5 million in a new plant for producing invisible makeup. The plant has an expected life of 5 years, and expected sales are 6 million jars of makeup a year.
The most likely outcomes for a particular project are estimated as follows:Unit price: $50Variable cost: $30Fixed cost: $300,000Expected sales: 30,000 units per yearHowever, you recognize that some
The inflation rate in the United States has averaged 3.1% a year since 1900. What was the average real rate of return on Treasury bills, Treasury bonds, and common stocks in that period? Use the data
Do you think it is possible for risk-free Treasury bills to offer a negative nominal interest rate? Might they offer a negative real expected rate of return?
The accompanying table shows annual stock prices on the Sulaco Stock Exchange in the republic of Costaguana for 2008-2013. Construct two stock market indexes, one using weights as in the Dow Jones
In February 2009, the Dow Jones Industrial Average was at a level of about 8,000. In February 2013, it was about 14,000. Would you expect the Dow in 2013 to be more or less likely to move up or down
Consider the following scenario analysis:a. Is it reasonable to assume that Treasury bonds will provide higher returns in recessions than in booms?b. Calculate the expected rate of return and
The common stock of Leaning Tower of Pita Inc., a restaurant chain, will generate payoffs to investors next year, which depend on the state of the economy, as follows:a. The company goes out of
The common stock of Escapist Films sells for $25 a share and offers the following payoffs next year:Calculate the expected return and standard deviation of Escapist. All three scenarios are equally
Use the data in the scenario analysis from Problem 14 and consider a portfolio with weights of .60 in stocks and .40 in bonds.In problem 14a. What is the rate of return on the portfolio in each
Which firms of each pair below would you expect to have greater market risk? a. General Steel or General Food Supplies b. Club Med or General Cinemas
Investments in long-term government bonds produced a negative average return during the period 1977-1981. How should we interpret this? Did bond investors in 1977 expect to earn a negative maturity
A stock will provide a rate of return of either -18% or +26%. a. If both possibilities are equally likely, calculate the stock's expected return and standard deviation. b. If Treasury bills yield 4%
Sassafras Oil is staking all its remaining capital on wildcat exploration off the Cote d'Huile. There is a 10% chance of discovering a field with reserves of 50 million barrels. If it finds oil, it
Log in to Connect or ask your instructor for access to the materials for Chapter 11. You will find a spreadsheet containing 5 years of monthly rates of return on ExxonMobil (XOM), BP, and Walmart
What will happen to the opportunity cost of capital if investors suddenly become especially conservative and less willing to bear investment risk?
If the stock market return next year turns out to be - 20 %, will our estimate of the "normal" risk premium increase or decrease? Does this make sense?
Top hedge fund manager Diana Sauros believes that a stock with the same market risk as the S&P 500 will sell at year-end at a price of $50. The stock will pay a dividend at year-end of $2. What
Here are stock market and Treasury bill percentage returns between 2008 and 2012:a. What was the risk premium on common stock in each year?b. What was the average risk premium?c. What was the
A stock is selling today for $40 per share. At the end of the year, it pays a dividend of $2 per share and sells for $44.a. What is the total rate of return on the stock?b. What are the dividend
You purchase 100 shares of stock for $40 a share. The stock pays a $2 per share dividend at year-end.a. What is the rate of return on your investment if the end-of-year stock price is(i) $38;(ii)
The Costaguanan stock market provided a rate of return of 95%. The inflation rate in Costaguana during the year was 80%. In the United States, in contrast, the stock market return was only 12%, but
In light of what you've learned about market versus diversifiable (specific) risks, explain why an insurance company has no problem in selling life insurance to individuals but is reluctant to issue
If the risk-free rate is 6% and the expected rate of return on the market portfolio is 13%, is a security with a beta of 1.25 and an expected rate of return of 16% overpriced or underpriced?
Consider the following two scenarios for the economy and the returns in each scenario for the market portfolio, an aggressive stock A, and a defensive stock D.a. Find the beta of each stock. In what
A share of stock with a beta of .75 now sells for $50. Investors expect the stock to pay a year-end dividend of $2. The T-bill rate is 4%, and the market risk premium is 7%. If the stock is perceived
A share of stock with a beta of .75 now sells for $50. Investors expect the stock to pay a year-end dividend of $2. The T-bill rate is 4%, and the market risk premium is 7%.a. Suppose investors
The following table shows betas for several companies. Calculate each stock's expected rate of return using the CAPM. Assume the risk-free rate of interest is 5%. Use a 7% risk premium for the market
Suppose that the S&P 500, with a beta of 1.0, has an expected return of 13% and T-bills provide a risk-free return of 4%.a. What would be the expected return and beta of portfolios constructed
Stock A has a beta of .5, and investors expect it to return 5%. Stock B has a beta of 1.5, and investors expect it to return 13%. Use the CAPM to find the market risk premium and the expected rate of
True or false? Explain or qualify as necessary. a. The expected rate of return on an investment with a beta of 2.0 is twice as high as the expected rate of return of the market portfolio. b. The
Figure 12.10 plots monthly rates of return from 2009 to 2013 for the Snake Oil mutual fund. Was this fund fully diversified? Explain.In figure 12.10
A mutual fund manager expects her portfolio to earn a rate of return of 11 % this year. The beta of her portfolio is .8. If the rate of return available on risk-free assets is 4% and you expect the
Reconsider the mutual fund manager in Problem 20. How could you mix a stock index mutual fund with a risk-free position in Treasury bills (or a money market mutual fund) to create a portfolio with
We Do Bankruptcies is a law firm that specializes in providing advice to firms in financial distress. It prospers in recessions, when other firms are struggling. Consequently, its beta is negative,
A project under consideration has an internal rate of return of 14% and a beta of .6. The risk-free rate is 4%, and the expected rate of return on the market portfolio is 14%.a. What is the
Suppose the Treasury bill rate is 4% and the market risk premium is 7%.a. What are the project costs of capital for new ventures with betas of .75 and 1.75?b. Which of the following capital
You are a consultant to a firm evaluating an expansion of its current business. The cash-flow forecasts (in millions of dollars) for the project are as follows:Years Cash Flow0
Reconsider the project in Problem 26. What is the project IRR? What is the cost of capital for the project? Does the accept-reject decision using IRR agree with the decision using NPV?
Suppose Cisco is considering a new investment in the common stock of a chocolate company. What is the required rate of return for this venture? Explain why the expected return on Cisco stock is not
Investors expect the market rate of return this year to be 14%. A stock with a beta of .8 has an expected rate of return of 12%. If the market return this year turns out to be 10%, what is your best
Footnote 5 in the chapter asks you to consider a borrow-and-invest strategy in which you use $1 million of your own money and borrow another $1 million to invest $2 million in a market index fund. If
Figure 12.11 shows plots of monthly rates of return on three stocks versus the stock market index. (The plots are similar to those in Figure 12.2 but are taken from an earlier period.) The beta and
Following are several months' rates of return for Tumblehome Canoe Company. Prepare a plot like Figure 12.1. What is Tumblehome's beta?
Suppose that the S&P 500, with a beta of 1.0, has an expected return of 10% and T-bills provide a risk-free return of 4%.a. How would you construct a portfolio from these two assets with an
Suppose that the risk premium on stocks and other securities did in fact rise with total risk (that is, the variability of returns) rather than just market risk. Explain how investors could exploit
You are considering acquiring a firm that you believe can generate expected cash flows of $ 10,000 a year forever. However, you recognize that those cash flows are uncertain.a. Suppose you believe
In 2013 Caterpillar Inc. had about 648 million shares outstanding. Their book value was $27 per share, and the market price was $83.50 per share. The company's balance sheet shows that the company
The common stock of Buildwell Conservation & Construction Inc. (BCCI) has a beta of .9. The Treasury bill rate is 4%, and the market risk premium is estimated at 8%. BCCl's capital structure is
The total book value of WTC's equity is $10 million, and book value per share is $20. The stock has a market-to-book ratio of 1.5, and the cost of equity is 15%. The firm's bonds have a face value
Nodebt Inc. is a firm with all-equity financing. Its equity beta is .80. The Treasury bill rate is 4%, and the market risk premium is expected to be 10%. a. What is Nodebt's asset beta? b. What is
Look at the following book-value balance sheet for University Products Inc. The preferred stock currently sells for $15 per share and pays a dividend of $2 a share. The common stock sells for $20 per
Geothermal's WACC is 11.4%. Executive Fruit's WACC is 12.3%. Now Executive Fruit is considering an investment in geothermal power production. a. Should it discount project cash flows at 12.3%? b.
The total market value of Okefenokee Real Estate Company's equity is $6 million, and the total value of its debt is $4 million. The treasurer estimates that the beta of the stock currently is 1.2 and
Universal Foods has a debt-to-value ratio of 40%, its debt is currently selling on a yield of 6%, and its cost of equity is 12%. The corporate tax rate is 40%. The company is now evaluating a new
Icarus Airlines is proposing to go public, and you have been given the task of estimating the value of its equity. Management plans to maintain debt at 30% of the company's present value, and you
You need to estimate the value of Laputa Aviation. You have the following forecasts (in millions of dollars) of its profits and of its future investments in new plant and working capital:From year 5
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