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Questions and Answers of
Corporate Finance
Your spouse works for Southwest Airlines and you work for a grocery store. Is your company or your spouse's company likely to be more exposed to systematic risk?
How does standard deviation relate to the general concept of risk?
Your portfolio consists of 100 shares of CSH and 50 shares of EJH, which you just bought at $20 and $30 per share, respectively. a. What fraction of your portfolio is invested in CSH? In EJH? b. If
What does correlation tell us?
Why isn't the total risk of a portfolio simply equal to the weighted average of the risks of the securities in the portfolio?
What does the WACC measure?
Why are market-based weights important?
Why is the coupon rate of existing debt irrelevant for finding the cost of debt capital?
Describe the steps involved in the CAPM approach to estimating the cost of equity.
Why would the CDGM and CAPM produce different estimates of the cost of equity capital?
Under what assumptions can the WACC be used to value a project?
What possible problems might be associated with the assumptions used in applying the WACC method?
How should you value a project in a line of business with risk that is different than the average risk of your firm's projects?
AllCity, Inc., is financed 40% with debt, 10% with preferred stock, and 50% with common stock. Its pretax cost of debt is 6%, its preferred stock pays an annual dividend of $2.50 and is priced at
Your firm is planning to invest in an automated packaging plant. Harburtin Industries is an all-equity firm that specializes in this business. Suppose Harburtin's equity beta is 0.85, the risk-free
Why does the stock price typically decrease when a firm announces an SEO?
What are the main differences between a firm commitment IPO and an auction IPO?
How is the price set in an auction IPO?
Why should a financial manager be concerned about under pricing?
Why is the yield on a convertible bond lower than the yield on an otherwise identical bond without a conversion feature?
How does a sinking fund provision affect the cash flows associated with a bond issue from the company's perspective? From a single bondholder's perspective?
What is the effect of including a call feature on the price a company can receive for its bonds?
You are thinking about buying Dovia Co.'s convertible bonds. You plan to convert to equity at the end of the year and you think that Dovia's common equity will be priced at $35 per share at that
Your firm is considering two one-year loan options for a $500,000 loan. The first carries fees of 2% of the loan amount and charges interest of 4% of the loan amount. The other carries fees of 1% of
Your firm has tangible assets of $100 million. You are planning to acquire a firm that is half your firm's size. You have bonds with a merger & acquisition covenant that requires the combined firm to
Braxton Enterprises currently has debt outstanding of $35 million and an interest rate of 8%. Braxton plans to reduce its debt by repaying $7 million in principal at the end of each year for the next
Absent tax effects, why can't we change the cost of capital of the firm by using more debt financing and less equity financing?
How can leverage alter the incentives of managers?
What is meant by "indirect costs of financial distress"?
Which type of firm is more likely to experience a loss of customers in the event of financial distress? a. Campbell Soup Company or Intuit, Inc. (a maker of accounting software)? b. Allstate
For each pair below, which type of asset is more likely to be liquidated for close to its full market value in the event of financial distress? a. An office building or a brand name? b. Product
Pelamed Pharmaceuticals had EBIT of $325 million in 2013. In addition, Pelamed had interest expenses of $125 million and a corporate tax rate of 40%.a. What was Pelamed's 2013 net income?b. What was
How can dividends and repurchases be used to signal managers' information about their firms' prospects?
Explain under which conditions an increase in the dividend payment can be interpreted as a signal of good news or bad news.
Why an announcement of a share repurchase is considered a positive signal?
Using Table 17.2, for each of the following years, state whether dividends were tax disadvantaged or not for individual investors with a one-year investment horizon:a. 1985b. 1989c. 1995d. 1999e. 2005
Clovix Corporation has $50 million in cash, 10 million shares outstanding, and a current share price of $30. Clovix is deciding whether to use the $50 million to pay an immediate special dividend of
What are the advantages and disadvantages of the percent of sales method?
What is gained by forecasting capital expenditures and external financing specifically?
What can the sustainable growth rate tell a financial manager and what can it not tell?
How can the financial manager use the long-term forecast to decide on adopting a new business plan?
Answer the following: a. What is the difference between a firm's cash cycle and its operating cycle? b. How will a firm's cash cycle be affected if it increases its inventory, all else being
What are the ways that receivables management can affect a firm's value?
The Greek Connection had sales of $32 million in 2013, and a cost of goods sold of $20 million. A simplified balance sheet for the firm appears below:a. Calculate The Greek Connection's net working
What are the different bank financing options and what are their relative advantages?
Is an increase in a stock's volatility good for the holder of a call option? Is it good for the holder of a put option?
Explain why an option can be thought of as an insurance contract.
Explain why equity can be viewed as a call option on a firm.
Why do you think mergers cluster in time, causing merger waves?
What are some reasons why a horizontal merger might create value for shareholders?
How does a toehold help overcome the free rider problem?
What are some reasons a financial manager would need to access the foreign exchange market?
What are the differences between hedging exchange rate risk with options versus forwards?
How are U.S. firms taxed on their foreign earnings?
The Beyond the Page feature, "Goldman Sachs Causes a Ruckus," describes the controversial involvement of Goldman Sachs in a mortgage-backed securities deal in 2006. When this involvement was
1. Look back to the numerical example graphed in Figure 1A.1. Suppose the interest rate is 20%. What would the ant (A) and grasshopper (G) do if they both start with $100,000? Would they invest in
Suppose that you take out a $200,000, 20-year mortgage loan to buy a condo. The interest rate on the loan is 6%, and payments on the loan are made annually at the end of each year.a. What is your
Explain why we refer to the opportunity cost of capital, instead of just "cost of capital" or "discount rate." While you're at it, also explain the following statement: "The opportunity cost of
Which of the following statements are true? The opportunity cost of capital:a. Equals the interest rate at which the company can borrow.b. Depends on the risk of the cash flows to be valued.c.
A 10-year U.S. Treasury bond with a face value of $1,000 pays a coupon of 5.5% (2.75% of face value every six months). The reported yield to maturity is 5.2% (a six-month discount rate of 5.2/2 =
Calculate durations and modified durations for the 3% bonds in Table 3.2. You can follow the procedure set out in Table 3.4 for the 9% coupon bonds. Confirm that modified duration closely predicts
Look again at Table 3.5. Suppose the spot interest rates change to the following downward-sloping term structure: r1 = 4.6%, r2 = 4.4%, r3 = 4.2% and r4 = 4.0%. Recalculate discount factors, bond
In February 2015 Treasury 4¾s of 2041 offered a semiannually compounded yield to maturity of 2.70%. Recognizing that coupons are paid semiannually, calculate the bond's price.
If a bond's yield to maturity does not change, the return on the bond each year will be equal to the yield to maturity. Confirm this with a simple example of a four-year bond selling at a premium to
The two-year interest rate is 10% and the expected annual inflation rate is 5%.a. What is the expected real interest rate?b. If the expected rate of inflation suddenly rises to 7%, what does Fisher's
Find the spreadsheet for Table 3.4. in Connect. Show how duration and volatility change if(a) The bond's coupon is 8% of face value and(b) The bond's yield is 6%. Explain your finding.TABLE 3.4
What spot interest rates are implied by the following Treasury bonds? Assume for simplicity that the bonds pay annual coupons. The price of a one-year strip is 97.56%, and the price of a four-year
Look one more time at Table 3.5.a. Suppose you knew the bond prices but not the spot interest rates. Explain how you would calculate the spot rates.b. Suppose that you could buy bond C in large
The following table shows the prices of a sample of U.S. Treasury strips in February 2012. Each strip makes a single payment of $1,000 at maturity.a. Calculate the annually compounded, spot interest
Construct a new version of Table 4.7, assuming that competition drives down profitability (on existing assets as well as new investment) to 11.5% in year 6, 11% in year 7, 10.5% in year 8, and 8% in
Phoenix Corp. faltered in the recent recession but is recovering. Free cash flow has grown rapidly. Forecasts made in 2016 are as follows.Phoenix's recovery will be complete by 2021, and there will
Construct a new version of Table 4.7, assuming that the concatenator division grows at 20%, 12%, and 6%, instead of 12%, 9%, and 6%. You will get negative early free cash flows.a. Recalculate the PV
If company Z (see Problem 5) were to distribute all its earnings, it could maintain a level dividend stream of $15 a share. How much is the market actually paying per share for growth
1. Help Jenny to forecast dividend payments for Reeby Sports and to estimate the value of the stock. You do not need to provide a single figure. For example, you may wish to calculate two figures,
You have the chance to participate in a project that produces the following cash flows:The internal rate of return is 13%. If the opportunity cost of capital is 10%, would you accept the offer?
Suppose you have the following investment opportunities, but only $90,000 available for investment. Which projects should you take?
1. Are the book rates of return reported in Tables 5.1 and 5.2 useful inputs for the capital investment decision?2. Calculate NPV and IRR for each process. What is your recommendation? Be ready to
Low-energy lightbulbs typically cost $3.60, have a life of nine years, and use about $2.00 of electricity a year. Conventional lightbulbs are cheaper to buy, for they cost only $.60. On the other
Look at the last question where you calculated the equivalent annual cost of producing reformulated gasoline in California. Capital investment was $400 million. Suppose this amount can be depreciated
Machine C was purchased five years ago for $200,000 and produces an annual real cash flow of $80,000. It has no salvage value but is expected to last another five years. The company can replace
In December 2005, Mid-American Energy brought online one of the largest wind farms in the world. It cost an estimated $386 million and the 257 turbines have a total capacity of 360.5 megawatts (mW).
Air conditioning for a college dormitory will cost $1.5 million to install and $200,000 per year to operate. The system should last 25 years. The real cost of capital is 5%, and the college pays no
A game of chance offers the following odds and payoffs. Each play of the game costs $100, so the net profit per play is the payoff less $100.What are the expected cash payoff and expected rate of
Table 7.9 shows standard deviations and correlation coefficients for eight stocks from different countries. Calculate the variance of a portfolio with equal investments in each stock.TABLE 7.9
Your eccentric Aunt Claudia has left you $50,000 in BP shares plus $50,000 cash. Unfortunately her will requires that the BP stock not be sold for one year and the $50,000 cash must be entirely
The following table shows the nominal returns on the U.S. stocks and the rate of inflation.a. What was the standard deviation of the nominal market returns?b. Calculate the arithmatic average real
Calculate the beta of each of the stocks in Table 7.9 relative to a portfolio with equal investments in each stock.TABLE 7.9
During the boom years of 2010-2014, ace mutual fund manager Diana Sauros produced the following percentage rates of return. Rates of return on the market are given for comparison.Calculate the
What is the beta of each of the stocks shown in Table 7.8?TABLE 7.8
Look back at the calculation for Johnson & Johnson and Ford in Section 8-1. Recalculate the expected portfolio return and standard deviation for different values of x1 and x2, assuming the
Look back at Problem 3 in Chapter 7. The risk-free interest rate in each of these years was as follows:a. Calculate the average return and standard deviation of returns for Ms. Sauros's portfolio and
The following table shows the sensitivity of four stocks to the three Fama-French factors. Estimate the expected return on each stock assuming that the interest rate is 2%, the expected risk premium
Between 1999 and 2008, the returns on Microfund averaged 4% a year. In his 2008 discussion of performance, the fund president noted that this was nearly 6% a year better than the return on the U.S.
Suppose that the Treasury bill rate is 6% rather than 2%. Assume that the expected return on the market stays at 9%. Use the betas in Table 8.2.a. Calculate the expected return from Johnson &
Refer to Table 7.5.a. What is the beta of a portfolio that has 40% invested in Ford and 60% in Johnson & Johnson?b. Would you invest in this portfolio if you had no superior information about the
Suppose a firm uses its company cost of capital to evaluate all projects. Will it underestimate or overestimate the value of high-risk projects?
Look again at Table 9.1. This time we will concentrate on Norfolk Southern.TABLE 9.1a. Calculate Norfolk Southern's cost of equity from the CAPM using its own beta estimate and the industry beta
A company is 40% financed by risk-free debt. The interest rate is 10%, the expected market risk premium is 8%, and the beta of the company's common stock is .5. What is the company cost of capital?
Refer to the top-right panel of Figure 9.2. What proportion of Dow Chemical's returns was explained by market movements? What proportion of risk was diversifiable? How does the diversifiable risk
Break-even calculations are most often concerned with the effect of a shortfall in sales, but they could equally well focus on any other component of cash flow. Dog Days is considering a proposal to
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