Questions and Answers of Contemporary Financial Management

What are the primary types of capital investment projects? Does a project’s type influence how it is analyzed? P=857
Cash flows for a particular project should be measured on an incremental basis and should consider all the indirect effects of the project. What does this involve? P=857
What factors should be considered when estimating a project’s NINV? P=857
Depreciation is a noncash expense; why is it considered when estimating a project’s net cash flows? P=857
What are the potential tax consequences of selling an old asset in an asset replacement investment decision? P=857
Why is it generally incorrect to consider interest charges when computing a project’s net cash flows? P=857
Distinguish between asset expansion and asset replacement projects. How does this distinction affect the capital expenditure analysis process? P=857
How is the opportunity cost concept used in the capital budgeting process? P=857
The Fleming Company, a food distributor, is considering replacing a filling line at its Oklahoma City warehouse. The existing line was purchased several years ago for $600,000. The line’s book
International Foods Corporation (IFC) currently processes seafood with a unit it purchased several years ago. The unit, which originally cost $500,000, currently has a book value of $250,000. IFC is
Homecraft Stores (HSI), which operates a chain of retail warehouse-type stores, is considering opening a new store in the Tampa area. The store itself will cost$7 million to build. In addition,
The Cooper Electronics Company has developed the following schedule of potential investment projects that may be undertaken during the next 6 months:Project Cost (in Millions of Dollars) Expected
Johnson Products is considering purchasing a new milling machine that costs$100,000. The machine’s installation and shipping costs will total $2,500. If accepted, the milling machine project will
What method of depreciation would you prefer, MACRS or straight-line, if your objective is to maximize the present value of your firm’s cash flows? P=857
Calculate the annual MACRS depreciation for a $20,000 truck that qualifies as a 5-year MACRS asset. The truck is estimated to have a $7,000 salvage value 6 years from now. P=857
Calculate the MACRS depreciation schedule for a drill press that costs $148,000 and has installation and shipping costs of $2,000. The drill press is classified as a 7-year MACRS asset P=857
Calculate the depreciation schedule for a $100,000 office building placed in service in October 2009. P=857
Consider again the SML given by Equation 8.18 and shown in Figure 8.15. Assume that the risk-free rate (^rf) of 6 percent is based on an expected inflation premium of 4 percent. Suppose expected
Suppose that a portfolio consists of the following stocks:Stock Amount Beta Chevron $20,000 0.70 General Electric 40,000 1.30 Whirlpool 40,000 1.10 The risk-free rate (^rf) is 5 percent and the
Two securities have the following characteristics:Security A Security B Expected return 15% 12%Standard deviation 4% 6%Beta 0.90 –0.25 Furthermore, the correlation of returns between the securities
a. Estimate beta for each of the following securities assuming that the standard deviation of returns for the market portfolio (m) is 8.0 percent.Security Expected Return Standard Deviation
Three Rivers Investment Company desires to construct a portfolio with a 20 percent expected return. The portfolio is to consist of some combination of Security X and Security Y, which have the
Equation 8.9 can be modified to compute the risk of a three-security portfolio as follows:p
Using Equation 8.17, suppose you have computed the required rate of return for the stock of Bulldog Trucking to be 16.6 percent. Given the current stock price, the current dividend rate, and
The real rate of interest has been estimated to be 3 percent, and the expected longterm annual inflation rate is 7 percent.a. What is the current risk-free rate of return on 1-year Treasury bonds?b.
Given a risk-free rate (^rf) of 6 percent and a market risk premium (^rm ^rf) of 8.1 percent, calculate the required rate of return on each of the following stocks, based on the betas given in Table
You have the following information on two securities in which you have invested:Security Expected Return Standard Deviation Beta Percent Invested (w)Xerox 15% 4.5% 1.20 35%Kodak 12% 3.8% 0.98 65%a.
You are considering investing in two securities, X and Y. The following data are available for the two securities:Security X Security Y Expected return 0.10 0.07 Standard deviation of returns 0.08
You have estimated the following probability distributions of expected future returns for Stocks X and Y:Stock X Stock Y Probability Return Probability Return 0.1 –10% 0.2 2%0.2 10 0.2 7 0.4 15 0.3
The yield to maturity on Xerox Corporation bonds maturing in 2014 is 8.40 percent. The yield to maturity on a similar maturity U.S. government Treasury bond is 7.55 percent. The yield to maturity on
The risk-free rate of return is 6 percent, based on an expected inflation premium of 3 percent. The expected rate of return on the market portfolio is 15 percent.a. Determine the required rate of
Determine the beta of a portfolio consisting of equal investments in the following common stocks:Security Beta Boeing .95 Daimler 1.25P=74 Intel 1.15 Wal-Mart Stores 1.05
Two common stocks, Consolidated Edison and Apple, have the following expected return and standard deviation of return over the next year:Additionally, assume that the correlation coefficient of
Given that the rate of return on General Electric common stock over the coming year is normally distributed with an expected value of 15 percent and a standard deviation of 12 percent, determine the
Given the following possible returns (dividends plus capital gains) over the coming year from a $10,000 investment in Ford Motor Company common stock:State of Economy Probability Return Recession
Is it possible for investors ever to require a lower rate of return on a company’s equity than on its debt, assuming that the debt is in a junk-bond category of quality?P=74
What is the primary difference between 20-year bonds issued by the U.S. government and 20-year bonds issued by IBM?P=74
Why do yield curves sometimes have a downward slope and at other times have an upward slope?P=74
What factors determine investors’ required rates of return on corporate bonds?Common stocks? U.S. government bonds?P=74
Discuss the general relationship between risk and expected return.P=74
How is risk defined in a financial sense?P=74
What is the risk structure of interest rates?P=74
What is the term structure of interest rates?P=74
The enclosed area in Figure 8.16 shows all the possible portfolios obtained by combining the given securities in different proportions (i.e., the opportunity set).a. Which of the portfolios (A, B, C,
Under what circumstances can the beta concept be used to estimate the rate of return required by investors in a stock? What problems are encountered when using the CAPM?P=74
How is a security’s beta value computed?P=74
The stock of Amrep Corporation has a beta value estimated to be 1.4. How would you interpret this beta value? How would you evaluate the firm’s systematic risk?P=74
What effect do increasing inflation expectations have on the required returns of investors in common stock?P=74
Distinguish between unsystematic and systematic risk. Under what circumstances are investors likely to ignore the unsystematic risk characteristics of a security?P=74
What are the primary variables that influence the risk of a portfolio of assets?P=74
Explain how diversification can reduce the risk of a portfolio of assets to below the weighted average of the risk of the individual assets.P=74
If inflation expectations increase, what would you expect to happen to the returns required by investors in bonds? What would happen to bond prices?P=74
What is the nature of the risk associated with “risk-free” U.S. government bonds?P=74
If the returns from a security were known with certainty, what shape would the probability distribution of returns graph have?P=74
The expected return from a portfolio of two or more securities is equal to the weighted average of the expected returns from the individual securities.P=74
Risk is also influenced by the possibility of investment diversification. If a proposed project’s returns are not perfectly correlated with the returns from the firm’s other investments, the
The required rate of return on a security is a function of the general level of interest rates, as reflected in the risk-free rate of return, the maturity risk of the security, the default risk of
The expected rate of return from a security reflects the distributions an investor anticipates receiving from an investment. The required rate of return reflects the return an investor demands as
The risk of a security or an investment project is generally defined in terms of the potential variability of its returns. When only one return is possible—for example, as with U.S. government
What is the risk of the portfolio?P=74
What return can be expected to be earned from the portfolio?P=74
The relationship between risk and required rate of return?P=74
The difference between the risk of an individual asset and the risk of an asset viewed as part of a portfolio P=74
The meaning of the concept of risk and measurement of risk?P=74
The Capital Asset Pricing Model (CAPM) can be used to determine required rates of return on investments in financial or physical assets.a. The systematic risk of a security refers to that portion of
Portfolios are composed of two or more assets.a. The risk of a portfolio of assets depends on the risk of the individual assets in the portfolio and the correlation of returns between the pairs of
The required rate of return on an investment and the perceived risk of the return expected have a positive relationship: the greater the risk, the greater the expected return.P=74
The required rate of return on an investment—financial asset (security) or physical asset—is equal to the risk-free rate of return plus a risk premium.a. The risk-free rate of return refers to
A probability distribution indicates the percentage chance of occurrence of each of the possible outcomes.a. The expected value is a measure of mean or average value of the possible outcomes, each
The characteristics of variable income (common stock) securities includea. Accounting aspectsb. Stockholder rightsc. Featuresd. Advantages and disadvantages? P=758
Investment bankers provide a number of important services within the operation of the capital markets. P=758
Methods of selling securities in the primary capital markets includea. Public cash offerringb. Direct placementc. Rights offering to shareholders P=758
In the general dividend valuation model, the value of a common stock is equal to the present value of all future dividend payments discounted at the investor’s required rate of return. P=758
In the constant growth dividend valuation model, the value of a common stock is equal to the next period’s dividend divided by the difference between the investor’s required rate of return and
A zero growth dividend valuation model can be used when a firm’s future dividend payments are expected to remain constant forever, as in a perpetuity. P=758
A nonconstant growth dividend valuation model uses the present value of yearly dividends plus the present value of the expected stock price at the end of the period of nonconstant growth. P=758
The valuation of small firm stock requires an explicit consideration of the marketability of that stock, whether the stock represents minority or majority ownership, and whether the stock is voting
The features and characteristics of common stocks? P=758
The securities offering process and the role of the investment banker? P=758
The valuation of common stocks? P=758
Define the following terms associated with common stock: P=758a. Nonvoting stockd. Stock dividendb. Stock splite. Book valuec. Reverse stock splitf. Treasury stock
Does the retained earnings figure on a company’s balance sheet indicate the amount of funds the company has available for current dividends or capital expenditures? Explain fully. P=758
Discuss the reasons why a firm may repurchase its own common stock. P=758
Explain the differences between par value, book value, and market value per share of common stock. P=758
Discuss the various stockholder rights. P=758
What factor or factors make the valuation of common stocks more complicated than the valuation of bonds and preferred stocks? P=758
According to the general dividend valuation model, a firm that reinvests all its earnings and pays no cash dividends can still have a common stock value greater than zero. How is this possible? P=758
Explain the relationship between financial decisions and shareholders’ wealth. P=758
In the context of the constant growth dividend valuation model, explain what is meant by: P=758a. Dividend yieldb. Price appreciation yield
Explain why the valuation models for a perpetual bond, preferred stock, and common stock with constant dividend payments (zero growth) are virtually identical. P=758
Explain how the book value per share of common stock can change over time. P=758
What is the difference between majority voting and cumulative voting? P=758
What are the primary functions served by investment bankers? P=758
What are the differences between a direct placement, a public cash offering, and a rights offering of securities? P=758
Which do you think is more risky for a firm trying to raise capital—an underwritten offering or a best-efforts offering? P=758
Identify the major issuance costs associated with a security offering by a corporation. P=758
How does a shelf registration differ from other public security offerings? P=758
The Edgar Corporation currently (D0) pays a $2 per share dividend. This dividend is expected to grow at a 20 percent annual rate over the next three years and then to grow at 6 percent per year for
Capitol Industries has 5 million shares of stock outstanding. In an election for the board of directors, 80 percent of the shares are voted. The company has seven directors on its board, all of whom
Referring to the following listing for Disney on April 1, 2010:10.20 35.60 17.82 Disney DIS 1.0 20 35.55 0.64 determine thea. Closing price on April 1, 2010b. Price change from the previous trading

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