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Questions and Answers of
Corporate Finance
You firm is considering the purchase of a new office phone system. You can either pay $32,000 now, or $1000 per month for 36 months. a. Suppose your firm currently borrows at a rate of 6% per year
After reading the Novy-Marz and Rauh paper you decide to compute the total obligation of the state that you live in. After some research you determine that your state's promised pension payments
Suppose you invest $100 in a bank account, and five years later it has grown to $134.39. a. What APR did you receive, if the interest was compounded semiannually? b. What APR did you receive if the
Consider the following bonds:Bond............Coupon Rate (annual payments)...................Maturity (years)A........................................ 0% ........................................
Suppose the current zero-coupon yield curve for risk-free bonds is as follows:a. What is the price per $100 face value of a two-year, zero-coupon, risk-free bond?b. What is the price per $100 face
Suppose that Ally Financial Inc. issued a bond with 10 years until maturity, a face value of $1000, and a coupon rate of 7% (annual payments). The yield to maturity on this bond when it was issued
Suppose you purchase a 30-year Treasury bond with a 5% annual coupon, initially trading at par. In 10 years' time, the bond's yield to maturity has risen to 7% (EAR). a. If you sell the bond now,
What is the price of a three-year, default-free security with a face value of $1000 and an annual coupon rate of 4%? What is the yield to maturity for this bond?
In the Data Case in Chapter 5, we suggested using the yield on Florida State bonds to estimate the State of Florida's cost of capital. Why might this estimate overstate the actual cost of capital?
What does it mean for a country to "inflate away" its debt? Why might this be costly for investors even if the country does not default?
Suppose the yield on German government bonds is 1%, while the yield on Spanish government bonds is 6%. Both bonds are denominated in euros. Which country do investors believe is more likely to
Explain why the yield of a bond that trades at a discount exceeds the bond's coupon rate?
You have 3 projects with the following cash flows:a.For which of these projects is the IRR rule reliable?b.Estimate the IRR for each project (to the nearest 1%).c.What is the NPV of each project if
You are CEO of Rivet Networks, maker of ultra-high performance network cards for gaming computers, and you are considering whether to launch a new product. The product, the Killer X3000, will cost
Consider again the choice between outsourcing and in-house assembly of HomeNet discussed in Section 8.3 and analyzed in Table 8.6. Suppose, however, that the upfront cost to set up for in-house
Consider the valuation of Kenneth Cole Productions in Example 9.7.a. Suppose you believe KCP's initial revenue growth rate will be between 4% and 11% (with growth slowing in equal steps to 4% by year
Consider the following data for the airline industry for December 2015 (EV = enterprise value, Book = tangible book value). Discuss the challenges of using multiples to value an airline.
Suppose Hawaiian Airlines (HA) has 53 million shares outstanding. Estimate Hawaiian's share value using each of the five valuation multiples in Problem 28, based on the median valuation multiple of
Proctor and Gamble paid an annual dividend of $1.72 in 2009. You expect P&G to increase its dividends by 8% per year for the next five years (through 2014), and thereafter by 3% per year. If the
Suppose Kenneth Cole Productions (KCP) is acquired at the end of 2012 for a purchase price of $15.25 per share. KCP has 18.5 million shares outstanding, $45 million in cash, and no debt at the time
In mid-2015, Coca-Cola Company (KO) had a share price of $41. Its dividend was $1.32 per year, and you expect Coca-Cola to raise this dividend by approximately 7% per year in perpetuity. a. If
No-Growth Corporation currently pays a dividend of $2 per year, and it will continue to pay this dividend forever. What is the price per share if its equity cost of capital is 15% per year?
Canadian-based mining company El Dorado Gold (EGO) suspended its dividend in March 2016 as a result of declining gold prices and delays in obtaining permits for its mines in Greece. Suppose you
Identify each of the following risks as most likely to be systematic risk or diversifiable risk: a. The risk that your main production plant is shut down due to a tornado. b. The risk that the
Suppose the risk-free interest rate is 5%, and the stock market will return either 40% or −20% each year, with each outcome equally likely. Compare the following two investment strategies: (1)
Suppose the market portfolio is equally likely to increase by 30% or decrease by 10%. a. Calculate the beta of a firm that goes up on average by 43% when the market goes up and goes down by 17% when
Suppose the risk-free interest rate is 4%. a. i. Use the beta you calculated for the stock in Problem 33(a) to estimate its expected return. ii. How does this compare with the stock's actual expected
Suppose Tex stock has a volatility of 40%, and Mex stock has a volatility of 20%. If Tex and Mex are uncorrelated,a. What portfolio of the two stocks has the same volatility as Mex alone?b. What
Using the same data as for Problem 23, calculate the expected return and the volatility (standard deviation) of a portfolio consisting of Johnson & Johnson's and Walgreen's stocks using a wide
The volatility of the market portfolio is 10% and it has an expected return of 8%. The risk-free rate is 3%.a. Compute the beta and expected return of each stock.b. Using your answer from part a,
Use the data in Problem 5, consider a portfolio that maintains a 50% weight on stock A and a 50% weight on stock B.a. What is the return each year of this portfolio?b. Based on your results from part
Using your estimates from Problem 5, calculate the volatility (standard deviation) of a portfolio that is 70% invested in stock A and 30% invested in stock B?
Using the data from Table 11.3, what is the covariance between the stocks of American Air Lines and Delta Air Lines?
Stock A has a volatility of 65% and a correlation of 10% with your current portfolio. Stock B has a volatility of 30% and a correlation of 25% with your current portfolio. You currently hold both
Fred holds a portfolio with a 30% volatility. He decides to short sell a small amount of stock with a 40% volatility and use the proceeds to invest more in his portfolio. If this transaction reduces
Assume all investors want to hold a portfolio that, for a given level of volatility, has the maximum possible expected return. Explain why, when a risk-free asset exists, all investors will choose to
Calculate the Sharpe ratio of each of the three portfolios in Problem 39. What portfolio weight in Hannah stock maximizes the Sharpe ratio?
When the CAPM correctly prices risk, the market portfolio is an efficient portfolio? Explain why.
In mid-2012, Ralston Purina had AA-rated, 10-year bonds outstanding with a yield to maturity of 2.05%. a. What is the highest expected return these bonds could have? b. At the time, similar maturity
Suppose the market portfolio has an expected return of 10% and a volatility of 20%, while Microsoft's stock has a volatility of 30%. a. Given its higher volatility, should we expect Microsoft to
In mid-2015, Cisco Systems had a market capitalization of $130 billion. It had A-rated debt of $25 billion as well as cash and short-term investments of $60 billion, and its estimated equity beta at
Your company operates a steel plant. On average, revenues from the plant are $30 million per year. All of the plants costs are variable costs and are consistently 80% of revenues, including energy
Consider the following stocks, all of which will pay a liquidating dividend in a year and nothing in the interim:a. Calculate the expected return of each stock.b. What is the sign of correlation
Using the factor beta estimates in the table shown here and the monthly expected return estimates in Table 13.1, calculate the risk premium of General Electric stock (ticker: GE) using the FFC
Assume that all investors have the same information and care only about expected return and volatility. If new information arrives about one stock, can this information affect the price and return
How does the disposition effect impact investors' tax obligations?
Consider the price paths of the following two stocks over six time periods:Neither stock pays dividends. Assume you are an investor with the disposition effect and you bought at time 1 and right now
Allison and Bill are both mutual fund managers, although Allison is more skilled than Bill. Both have $100 million in assets under management and charge a fee of 1%/year. Allison is able to generate
Explain why you might expect stocks to have nonzero alphas if the market proxy portfolio is not highly correlated with the true market portfolio, even if the true market portfolio is efficient?
Explain why, if some investors are subject to systematic behavioral biases while others pick efficient portfolios, the market portfolio will not be efficient?
Explain why an employee who cares only about expected return and volatility will likely underweight the amount of money he invests in his own company's stock relative to an investor who does not
Suppose the CAPM equilibrium holds perfectly. Then the risk-free interest rate increases, and nothing else changes. a. Is the market portfolio still efficient? b. If your answer to part (a) is yes,
You know that there are informed traders in the stock market, but you are uninformed. Describe an investment strategy that guarantees that you will not lose money to the informed traders and explain
Explain what the following sentence means: The market portfolio is a fence that protects the sheep from the wolves, but nothing can protect the sheep from themselves?
Zetatron is an all-equity firm with 100 million shares outstanding, which are currently trading for $7.50 per share. A month ago, Zetatron announced it will change its capital structure by borrowing
Suppose Visa Inc. (V) has no debt and an equity cost of capital of 9.2%. The average debt-to-value ratio for the credit services industry is 13%. What would its cost of equity be if it took on
Mercer Corp. has 10 million shares outstanding and $100 million worth of debt outstanding. Its current share price is $75. Mercer's equity cost of capital is 8.5%. Mercer has just announced that it
In mid-2015, Qualcomm Inc. had $11 billion in debt, total equity capitalization of $89 billion, and an equity beta of 1.43 (as reported on Yahoo! Finance). Included in Qualcomm's assets was $21
Jim Campbell is founder and CEO of Open-Start, an innovative software company. The company is all equity financed, with 100 million shares outstanding. The shares are trading at a price of $1.
Zelnor, Inc., is an all-equity firm with 100 million shares outstanding currently trading for $8.50 per share. Suppose Zelnor decides to grant a total of 10 million new shares to employees as part of
Facebook, Inc. had no debt on its balance sheet in 2014, but paid $2 billion in taxes. Suppose Facebook were to issue sufficient debt to reduce its taxes by $250 million per year permanently. Assume
Safeco Inc. has no debt, and maintains a policy of holding $10 million in excess cash reserves, invested in risk-free Treasury securities. If Safeco pays a corporate tax rate of 35%, what is the cost
You work for a large car manufacturer that is currently financially healthy. Your manager feels that the firm should take on more debt because it can thereby reduce the expense of car warranties. To
Real estate purchases are often financed with at least 80% debt. Most corporations, however, have less than 50% debt financing. Provide an explanation for this difference using the tradeoff theory?
On May 14, 2008, General Motors paid a dividend of $0.25 per share. During the same quarter GM lost a staggering $15.5 billion or $27.33 per share. Seven months later the company asked for billions
Although the major benefit of debt financing is easy to observe-the tax shield-many of the indirect costs of debt financing can be quite subtle and difficult to observe. Describe some of these costs?
When a firm defaults on its debt, debt holders often receive less than 50% of the amount they are owed. Is the difference between the amount debt holders are owed and the amount they receive a cost
During the Internet boom of the late 1990s, the stock prices of many Internet firms soared to extreme heights. As CEO of such a firm, if you believed your stock was significantly overvalued, would
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 inventory or raw
On Monday, November 15, 2004, TheStreet.com reported: "An experiment in the efficiency of financial markets will play out Monday following the expiration of a $3.08 dividend privilege for holders of
At current tax rates, which of the following investors are most likely to hold a stock that has a high dividend yield: a. Individual investors? b. Pension funds? c. Mutual funds? d. Corporations?
Que Corporation pays a regular dividend of $1 per share. Typically, the stock price drops by $0.80 per share when the stock goes ex-dividend. Suppose the capital gains tax rate is 20%, but investors
A stock that you know is held by long-term individual investors paid a large one-time dividend. You notice that the price drop on the ex-dividend date is about the size of the dividend payment. You
Harris Corporation has $250 million in cash, and 100 million shares outstanding. Suppose the corporate tax rate is 35%, and investors pay no taxes on dividends, capital gains, or interest income.
Suppose you work for Oracle Corporation, and part of your compensation takes the form of stock options. The value of the stock option is equal to the difference between Oracle's stock price and an
Parnassus Corporation plans to invest $150 million in a new generator that will produce free cash flows of $20 million per year in perpetuity. The firm is all equity financed, with an equity cost of
In 2015, Intel Corporation had a market capitalization of $134 billion, debt of $13.2 billion, cash of $13.8 billion, and EBIT of nearly $16 billion. If Intel were to increase its debt by $1 billion
Backcountry Adventures is a Colorado-based outdoor travel agent that operates a series of winter backcountry huts. Currently, the value of the firm (debt + equity) is $3.5 million. But profits will
Consider the October 2015 IBM call and put options in Problem 3. Ignoring any interest you might earn over the remaining few days' life of the options: a. Compute the break-even IBM stock price for
It is October 5, 2015, and you own IBM stock. You would like to insure that the value of your holdings will not fall significantly. Using the data in Problem 3, and expressing your answer in terms of
Consider the October 2015 IBM call and put options in Problem 3. Ignoring the negligible interest you might earn on T-Bills over the remaining few days' life of the options, show that there is no
In mid-February 2016, European-style options on the S&P 100 index (OEX) expiring in December 2017 were priced as follows:Dec 2017 OEX Index OptionsStrike Price..........Call
Suppose Amazon stock is trading for $500 per share, and Amazon pays no dividends. a. What is the maximum possible price of a call option on Amazon? b. What is the maximum possible price of a put
Consider the data for IBM options in Problem 3. Suppose a new American-style put option on IBM is issued with a strike price of $155 and an expiration date of November 1st. a. What is the maximum
You are watching the option quotes for your favorite stock, when suddenly there is a news announcement. Explain what type of news would lead to the following effects: a. Call prices increase, and put
Consider an American put option on XAL stock with a strike price of $55 and one year to expiration. Assume XAL pays no dividends, XAL is currently trading for $10 per share, and the one-year interest
Consider the United Studio in Section 22.2. Suppose United has the rights to produce the first film, but has not yet purchased the sequel rights. a. How much are the sequel rights worth to United? b.
Describe the benefits and costs of delaying an investment opportunity?
Three years ago, you founded Outdoor Recreation, Inc., a retailer specializing in the sale of equipment and clothing for recreational activities such as camping, skiing, and hiking. So far, your
You have an arrangement with your broker to request 1000 shares of all available IPOs. Suppose that 10% of the time, the IPO is "very successful" and appreciates by 100% on the first day, 80% of the
Your robotic automation startup, Kela Controls, has raised capital as follows:Funding RoundPre-MoneyPost-MoneySeries A .......................... $8 million ............. $12 millionSeries B
Beru.com recently raised $5 million with a pre-money value of $9 million. They are seeking to raise another $6 million. What is the largest fraction of the firm they can offer and avoid a down round?
BitBox has raised $10 million in a Series A round with $40 million post-money value and a 1.5x liquidation preference, and $25 million in a Series B round with a $75 million post-money value and a 3x
What are the main advantages and disadvantages of going public?
On January 15, 2013, the U.S. Treasury issued a five-year inflation-indexed note with a coupon of 3%. On the date of issue, the consumer price index (CPI) was 250. By January 15, 2018, the CPI had
Suppose Microsoft is considering the purchase of computer servers and network infrastructure to expand its very successful business offering cloud-based computing. In total, it will purchase $48
The Greek Connection had sales of $32 million in 2015, 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
Ohio Valley Homecare Suppliers, Inc. (OVHS), had $20 million in sales in 2015. Its cost of goods sold was $8 million, and its average inventory balance was $2,000,000. a. Calculate the average number
What are the three steps involved in establishing a credit policy?
Why might a company choose to finance permanent working capital with short-term debt?
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