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Questions and Answers of
Corporate Finance
Given the following information from Capstone Corporation, what price would CAPM predict that the company's stock will trade for 1 year from today. Assume that the risk free rate is 3 percent and
You are considering investing in a mutual fund. The fund is expected to earn a return of 15 percent in the next year. If its annual return is normally distributed with a standard deviation of 6.5
You have just invested in a portfolio of three stocks. The amount of money that you invested in each stock and its beta are summarized below. Calculate the beta of the portfolio and use the capital
What would you recommend to an investor who is considering making an investment in a stock which plots below the security market line (SML)? Explain.
Why does an investor want a diversified portfolio? Can an investor eliminate all risk?
What is interest rate risk?
Calculate the price of a five-year bond that has a coupon of 6.5 percent paid annually. The current market rate is 5.75 percent?
Bigbie Corp. issued a five-year bond a year ago with a coupon of 8 percent. The bond pays interest semiannually. If the yield to maturity on this bond is 9 percent, what is the price of the bond?
Rockwell Industries has a three-year bond outstanding that pays a 7.25 percent coupon and is currently priced at $913.88. What is the yield to maturity of this bond? Assume annual coupon payments?
Hindenberg, Inc., has a 10-year bond that is priced at $1,100.00. It has a coupon of 8 percent paid semiannually. What is the yield to maturity on this bond?
Highland Corp. a U.S. company, has a five-year bond whose yield to maturity is 6.5 percent. The bond has no coupon payments. What is the price of this zero coupon bond?
Seven years ago Eastern Corporation issued 20-year bonds that had a $1000 face value, paid interest annually, and that had a coupon rate of 7 percent. If the market rate of interest is 5.5 percent
You are considering investing in a 10-year zero coupon bond that compounds interest semiannually. If the current market rate is 5.65 percent, what is the maximum price you should have pay for this
Bigbox, Inc. has bonds outstanding that will mature in eight years. These bonds pay interest semiannually and have a coupon rate of 4.6 percent. If the bonds are currently selling at $888.92, what is
Given a change in market interest rates, which will change more; the market price of a bond with 20 years until maturity or the market price of a bond with 5 years until maturity? Assume all the
Ted McKay has just bought the common stock of Ryland Corp. The company expects to grow at the following rates for the next three years: 30 percent, 25 percent, and 15 percent. Last year the company
Merriweather Manufacturing Company has been growing at a rate of 6 percent for the past two years, and the CEO expects the company to continue to grow at this rate for the next several years. The
Clarion Corp. has been selling electrical supplies for the past 20 years. The company's product line has changed very little in the past five years, and the company's management does not expect to
Barrymore Infotech is a fast growing communications company. The company did not pay a dividend last year and is not expected to do so for the next two years. Last year the company's growth
You are interested in buying the preferred stock of a bank that pays a dividend of $1.80 every quarter. If you discount such cash flows at 8 percent, what is the value of this stock?
Facebook does not pay dividends. How can it have a positive stock price?
The First Bank of Flagstaff has issued perpetual preferred stock with a $100 par value. The bank pays a quarterly dividend of $1.65 on this stock. What is the current price of this preferred stock
Tre-Bien, Inc., is a fast-growing technology company. Management projects rapid growth of 30 percent for the next two years, then a growth rate of 17 percent for the following two years. After that,
Is preferred stock a debt or an equity security?
Abacus Corporation will pay dividends of $2.25, $2.95, and $3.15in the next three years. After three years, the dividends are expected to grow at a constant rate of 4 percent per year. If the
The preferred stock of Wellcare Inc.is currently trading at $137.50 per share. If the required rate of return is 8 percent and this stock has no maturity date, what is the quarterly dividend paid by
The Management of Premium Manufacturing Company is evaluating two forklift systems to use in its plant that produces the towers for a windmill power farm. The costs and the cash flows from these
Perryman Crafts Corp. management is evaluating two independent capital projects that together will cost the company $250,000. The two projects will provide the following cash flows:Which project will
Terrell Corp. management is considering purchasing a machine that will cost $117,250 and will be depreciated on a straight-line basis over a five-year period. The sales and expenses (excluding
Refer to Problem 9.1. Compute the IRR for each of the two systems. Is the investment decision different from the one determined by NPV?
You are considering a project that has an initial outlay of $1 million. The profitability index of the project is 2.24. What is the NPV of the project?
a. Sykes, Inc. management is considering two projects: a plant expansion and a new computer system for the firm's production department. Classify these projects as independent, mutually exclusive, or
Riggs Corp. management is planning to spend $650,000 on a new- marketing campaign. They believe that this action will result in additional cash flows of $325,000 over the next three years. If the
Kingston, Inc. management is considering purchasing a new machine at a cost of $4,133,250. They expect this equipment to produce cash flows of $814,322, $863,275, $937,250, $1,017,112, $1,212,960,
Crescent Industries management is planning to replace some existing machinery in its plant. The cost of the new equipment and the resulting cash flows are shown in the accompanying table. If the firm
Management of Franklin Mints, a confectioner, is considering purchasing a new jellybean-making machine at a cost of $312,500. They project that the cash flows from this investment will be $121,450
Blanda Incorporated management is considering investing in two alternative production systems. The systems are mutually exclusive, and the cost of the new equipment and the resulting cash flows are
Explain why the announcement of a new investment is usually accompanied by a change in the firm's stock price?
In calculating the NPV of a project, should we use all of the after-tax cash flows associated with the project, or incremental after-tax cash flows from the project? Why?
You are considering opening another restaurant in the TexasBurgers chain. The new restaurant will have annual revenue of $300,000 and operating expenses of $150,000. The annual depreciation and
Sprigg Lane Manufacturing, Inc., needs to purchase a new central air-conditioning system for a plant. There are two choices. The first system costs $50,000 and is expected to last 10 years, and the
If you had to choose between one project with an expected life of five years and a second project with an expected life of six years, how could you do this without using the equivalent annual cost
You have a 2000 Nissan that is expected to run for another three years, but you are considering buying a new Hyundai before the Nissan wears out. You will donate the Nissan to Goodwill when you buy
A division of Virginia City Highlands Manufacturing is considering purchasing for 1,500,000a machine that automates the process of inserting electronic components onto computer motherboards. The
After examining the NPV analysis for a potential project that would increase the firm's output by 5 percent, an analyst's manager tells the analyst to increase the initial fixed capital outlay in the
Managers of Central Embroidery have decided to purchase a new monogram machine and are considering two alternative machines. The first machine costs $100,000 and is expected to last five years. The
You have inherited an apple orchard and want to sell it in the next four years. An expert in apple orchard valuation has estimated the after-tax cash flow you would receive if you sold at the end of
The Yellow Shelf Company sells all of its shelves for $100 per shelf, and incurs $50 in variable costs to produce each. If the fixed costs for the firm are $2,000,000 per year, what will the EBIT for
Hydrogen Batteries sells its specialty automobile batteries for $85 each, while its current variable cost per unit is $65.Total fixed costs (including depreciation and amortization expense) are
The Vinyl CD Co. is going to take on a project that is expected to increase its EBIT by $90,000, its fixed cost cash expenditures by $100,000, and its depreciation and amortization by $80,000 next
You are considering investing in a business that has monthly fixed costs of $5,500 and sells a single product that costs $35 per unit to make. This product sells for $90 per unit. What is the annual
Belt Bottoms, Inc. is considering a five-year project with an initial investment of $20,000. What annual free cash flow (FCF) would be required for this project to have an NPV of $0 if the
The economics break-even calculation assumes that the number of units sold is the same each year during the life of the project. It is possible for the NPV of a project to be negative if unit sakes
How does the pretax operating cash flow for a project differ from the economic profit for that project?
Management of March and Dine Inc. has estimated that the firm's new TV dinner project must generate $10,200 in FCF during each of the next six years to have an NPV of $0. Management anticipates that
Rose Weiser Company Management is considering a project that will require an initial investment of $50,000 and will last for 10 years. No other capital expenditures or increases in working capital
The BowGus Archery Company management estimates that its new Galactically Flexible Bow project will have to generate EBIT of $20,000 each year to be viable. The project's fixed cash expenses are
Commodore Motors management is considering a project to produce toy cars. The project would require an initial outlay of $100,000 and have an expected life of 10 years. Management estimates that each
Retro Inc. sells vintage football jerseys for $72 each. Variable costs are $58 per unit and total fixed costs (including depreciation and amortization expense) are $84,000 per year. If sales for next
How would a capital intensive company fare during good and poor economic times as compared with other companies? Explain.
The manager of Roy's Restaurant has determined that if revenues were to increase by 20 percent, then EBIT would increase by 45 percent to $87,000. What would be the corresponding change in EBITDA if
Luminosity Inc. produces modern light fixtures that sell for $150 per unit. The firm's management is considering purchasing a high-capacity manufacturing machine. If the high-capacity machine is
Paper Christmas Trees Inc. is considering introducing a new line of inexpensive Christmas trees. The initial outlay for the project is $175,000, and the company will have to invest $5,000 in working
The market value of a firm's assets is $3 billion. If the market value of the firm's liabilities is $2 billion, what is the market value of the stockholders' investment and why?
Berron Comics, Inc., has borrowed $100 million and is required to pay its lenders $8 million in interest this year. If Berron is in the 35 percent marginal tax bracket, then what is the after-tax
Explain why the after-tax cost of equity (common or preferred) does not have to be adjusted by the marginal income tax rate for the firm?
Mike's T-Shirts, Inc., has debt claims of $400 (market value) and equity claims of $600 (market value). If the after-tax cost of debt financing is 11 percent and the cost of equity is 17 percent,
You are analyzing a firm that is financed with 60 percent debt and 40 percent equity. The current cost of debt financing is 10 percent, but due to a recent downgrade by the rating agencies, the
What are direct out of pocket costs?
Explain why the total value of all of the securities used to finance a firm must be equal to the value of the firm?
What is the weighted average cost of capital for a firm?
Howard Power and Telecommunications Corporation has three divisions. The names of these divisions, along with the after-tax cost of capital for each division and the market value of the assets in
Quarri Industries has eight percent coupon bonds outstanding. These bonds have a market price of $954.41, pay interest semiannually, and will mature in 6 years. If the tax rate is 35 percent, what
Use the information in questions 13.2 and 13.3 as well as the following information to compute the WACC for Quarri Industries. In addition to common stock, Quarri has 500,000 preferred shares
Staunton Energy Corporation managers are considering a capital budgeting project to replace some machinery used in one of the company's oil refineries. Is the company's WACC the appropriate discount
What does "4/15, net 30" mean?
You are provided the following working capital information for the Blue Ridge Company:If all sales are made on credit, what are the firm's operating and cash conversion cycles?
Merrifield Cosmetics calculates that its operating cycle for last year was 76 days. The company had $230,000 in its accounts receivable account and had sales of $1.92 million. Approximately how
Below is a partial aging of accounts receivable for Bitar Roofing Services. Fill in the rest of the information and determine Bitar's days' sales outstanding. How does it compare to the industry
By obtaining a lockbox, Nizam's Manufacturing was able to reduce its total cash collection time by two days. The firm has annual sales of $570,000 and can earn 4.75 percent annual interest. Assuming
Rockville Corporation is going to borrow $250,000 from its bank at an APR of 8.5 percent. The bank requires its customers to maintain a 10 percent compensating balance. What is the effective interest
The Whole Foods Market, Inc. balance sheet for the fiscal year ending September 29, 2013 included the following: total current assets of $1,980 million, total assets of $5,538 million, total current
Last year Perpetual Plastics Company took an average of 46 days to pay suppliers and 38 days to collect its receivables. The company's average days' sales in inventory was 52 days. What was
Montrose, Inc. sells its products with terms of 3/15 EOM, net 30. What is the cost of the trade credit it provides its customers?
Sunny Way Landscaping has a formal line of credit of $500,000 with First Commerce Bank. The interest rate on the loan is 6 percent, and under the agreement, Sunny Skies must pay an annual fee of 75
Management of The Stride Rite Corporation, designer and marketer of athletic apparel, is planning an expansion into foreign markets and needs to raise $10 million to finance this move. Management
A majority of firms choose a firm-commitment underwriting arrangement rather than a best-effort arrangement for their IPO? Explain why.
Why might a negotiated sale be the lowest cost means of issuing a complex debt security?
Why are traditional sources of funding not usually available for new or emerging businesses?
A firm is making an initial public offering. The investment bankers agree to a firm underwriting commitment for 500,000 shares that would be priced to the public at $36 a share. The underwriter's
Hilton Worldwide Holdings Inc. completed an initial public offering on December 12, 2013. The offer price was $20.00 per share and the closing price at the end of the first day was $21.50. The firm
SMA Inc. is considering issuing the following securities. For which security would a competitive sale be less costly than a negotiated sale under stable market conditions? Why? a) Plain vanilla
If any of the three assumptions in Modigliani and Miller Proposition 1 are relaxed, which has the most predictably quantifiable impact on the value of the firm?
If we assume that the cash flows for a firm with financial leverage are equal to the cash flows for the same firm without financial leverage, what can we say about the value of this firm if its cost
Are taxes necessary for the cost of debt financing to be less than the cost of equity financing?
You are offered jobs with identical responsibilities by two different firms in the same industry. One has no debt in its capital structure, and the other has 99 percent debt in its capital structure.
You are valuing two otherwise identical firms in the same industry. One firm has a corporate jet for every executive at the vice president level and above, while the other does not have a single
According to the trade-off theory: a. The amount of debt a company has is irrelevant. b. Debt should be used only as a last resort. c. Debt will not be used if a company's tax rate is high. d.
Central Grocers Inc. produces annual cash flows of $175,000, which are expected to continue indefinitely. The company is financed entirely with equity capital at an annual cost of 12 percent.
The required rate of return on the assets of a firm is 12 percent, the firm has a debt-to-common-stock ratio of 40 percent, and the cost of debt is 6 percent. If the firm has no preferred stock and
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