Questions and Answers of Corporate Finance 5th Edition

Bose plc has developed a design for a new iPod docking station, and is considering whether it is viable to produce the product as a replacement for its existing product, whose popularity has
Gemini plc, an all-equity firm, is considering a €2.4 million investment that will be depreciated according to 25 per cent reducing balances. At the end of its 4-year life, the investment will be
Milano Pizza owns three identical restaurants popular for their specialty pizzas. Each restaurant has a debt–equity ratio of 40 per cent and makes interest payments of€29,500 at the end of each
Cryo NV is an all-equity firm involved in property and casualty insurance.However, Cryo is about to issue a 10-year bond issued at par with a coupon of 8 per cent.Prior to the bond issue, the firm
If Wild Widgets were an all-equity company, it would have a beta of 1.1. The company has a target debt–equity ratio of 0.40. The expected return on the market portfolio is 13 per cent, and Treasury
Maersk A/S and Lundberg A/S would have identical equity betas of 0.9 if both were all equity financed. The market value information for each company is shown here:The expected return on the market
Daniel Kaffe, CFO of Kendrick Enterprises, is evaluating a 6-year, 13 per cent loan with gross proceeds of €9,000,000. The interest payments on the loan will be made annually. Flotation costs are
Station GmbH is a German all-equity firm which is about to issue a new 10-year, 17 per cent bond with interest paid annually. The debt issue of €10 million is to fund an expansion of the firm’s
Shattered Glass plc is an all-equity firm. The cost of the company’s equity is currently 22 per cent, and the risk-free rate is 3 per cent. The company is currently considering a project that will
XYZ plc is considering purchasing new equipment that would cost £40 million.The expected unlevered cash flows from this investment are £13 million per annum for the next 5 years. The company’s
Bolero plc has compiled the following information on its financing costs:The company is in the 28 per cent tax bracket and has a target debt–equity ratio of 60 per cent.The target short-term
Letlago plc has established a joint venture with Wannako Ltd to build a new gold mine in Kenya. The initial investment in paving equipment is £12 million. The equipment will be depreciated using the
MVP GmbH has produced football supplies for over 20 years. The company currently has a debt–equity ratio of 50 per cent and is in the 29.8 per cent tax bracket. The required return on the firm’s
Neon Corporation’s share price returns have a covariance with the market portfolio of 0.048. The standard deviation of the returns on the market portfolio is 20 per cent, and the expected market
Seger plc is an unlevered firm with expected annual earnings before taxes of £35 million in perpetuity. The current required return on the firm’s equity is 20 per cent, and the firm distributes
Mojito Mint Company has a debt–equity ratio of 0.45. The required return on the company’s unlevered equity is 17 per cent, and the pre-tax cost of the firm’s debt is 9 per cent. Sales revenue
Lone Star Industries has just issued £160,000 of perpetual 10 per cent debt and used the proceeds to repurchase equity. The company expects to generate£75,000 of earnings before interest and taxes
Blue Angel Ltd, a private firm in the holiday gift industry, is considering a new project. The company currently has a target debt–equity ratio of 0.40, but the industry target debt–equity ratio
Read the paper by M. Massari, F. Roncaglio and L. Zanetti, ‘On the Equivalence between the APV and the WACC Approach in a Growing Leveraged Firm’, European Financial Management, Vol. 14, No. 1,
Select a range of empirical studies on capital budgeting and discuss their findings. What, in your opinion, are the most interesting findings?
After graduating from university you get a job for a non-dividend paying company which has recently listed on the stock exchange. Your manager tells you that the company does not favour the NPV
Electrolar AB is planning to set up new operations in northern Sweden. Having established that the investment has a positive net present value, they now have to consider their financing decision. The
What are the main characteristics of a bond? Provide examples of different types of bonds in terms of coupons, maturity and face value.
Show how you would value a level coupon bond and a zero coupon bond.How would you value a bond with a changing coupon rate?
Explain the difference between a coupon rate and a yield to maturity. Show, using examples, how changing the coupon rate and yield to maturity affects the bond price.
Explain why the share price depends on dividends and capital gains.
Under what two assumptions can we use the dividend growth model to determine the share price? Comment on the reasonableness of these assumptions.
In the context of the dividend growth model, is it true that the growth rate in dividends and the growth rate in the share price are identical?
Explain what is meant by NPVGO. In what circumstances is calculating the NPVGO better than other methods of share valuation?
What are the three factors that determine a company’s price–earnings ratio? Explain the possible reasons why the PE ratios vary between firms within the same sector, and between firms in
What information might a financial analyst need when valuing a company’s prospects? Comment on the usefulness of this information.
A 30-year gilt is issued with face value of £100, paying interest of £20 per year. If market yields increase shortly after the bond is issued, what happens to the:(a) Coupon rate(b) Price(c) Yield
In March 2012, the French bank, RCI Banque, issued an 18-month bond with a face value of €10,000, and an annual coupon rate of 2 per cent, paid every quarter. The issue price was €9,984.50. What
Your manager has obtained the following information on comparable stocks A and B, both of which are estimated to have a discount rate of 15 per cent.Calculate the dividend payout ratios for each
A2A SpA is an Italian utility firm. Its most recent dividend was €0.013 per share. In the past year, the company has experienced financial difficulties and the share price has dropped by more than
ABC plc pays dividends that are expected to grow at 5 per cent each year.These will stop in year 5, at which point the company will pay out all its earnings as dividends. Next year’s dividend is
If Severn Trent plc were to distribute all its earnings, it could maintain a level dividend stream of £0.67 per share. How much is the market actually paying per share for growth opportunities?
XYZ plc will pay a dividend next year of 40p per share, and it is estimated that XYZ’s dividend will increase by 4 per cent per year forever. Investors in XYZ require a rate of return of 10 per
Define each of the following terms:(i) Treasury bill(ii) Pure discount bond(iii) Index-linked bond.Which G7 country has the highest average maturity of debt stock? Why do you think this is?
The UK government issues a 5-year bond which makes annual coupon payments of 5 per cent and offers a yield of 3 per cent annually compounded. Suppose that one year later the bond still yields 3 per
Dylan Bearings is a young start-up company. No dividends will be paid on the shares over the next 9 years because the firm needs to plough back its earnings to fuel growth. The company will pay an
Mark Bank has just issued some new preference shares.The issue will pay a £5 annual dividend in perpetuity, beginning 4 years from now. If the market requires an 8 per cent return on this
The return on equity (ROE) of Child SA is 14 per cent and it has a payout ratio of 0.5. Current book value per share is €50 and the book value will grow as the firm reinvests earnings. Assume that
The Belgian food group, Delhaize, has just paid a dividend of €1.08. This is paid in semi-annual instalments. The firm has a policy to pay out 75 per cent of its annual dividend after 6 months and
Regenboog NV earned €68 million for the fiscal year ending yesterday. The firm also paid out 25 per cent of its earnings as dividends yesterday. The firm will continue to pay out 25 per cent of its
The market consensus is that Pinto plc has an ROE of 9 per cent, a beta of 1.25, and plans to maintain its plowback ratio of 0.67. This year’s earnings per share was €3. The consensus view of the
For Pinto plc in question 24 above, what is the present value of growth opportunities?Question 24The market consensus is that Pinto plc has an ROE of 9 per cent, a beta of 1.25, and plans to maintain
Yorkshire Property Ltd expects to earn £60 million per year in perpetuity if it does not undertake any new projects. The firm has an opportunity to invest £10 million today and £12 million in one
The ABC plc cash flow statement for the latest financial year is given below. The appropriate discount and growth rates are 14 per cent and 4 per cent, respectively. Assume the marginal corporate tax
The annual earnings of Avalanche Skis will be 6 Swedish kroner per share in perpetuity if the firm makes no new investments. Under such a situation the firm would pay out all of its earnings as
Larsen & Toubro Ltd (www.larsentoubro.com) is an Indian multinational conglomerate listed on the Bombay Stock Exchange. In the financial year 2011, the company’s net income was 4,456 crore, EPS was
Bond P is a premium bond with a 10 per cent coupon. Bond D is a 7 per cent coupon bond currently selling at a discount. Both bonds make annual payments, have a YTM of 9 per cent, and have 5 years to
The YTM on a bond is the interest rate you earn on your investment if interest rates do not change. If you actually sell the bond before it matures, your realized return is known as the holding
Man SE is a German commercial vehicle manufacturer. Its DPS and EPS for 2011 were €2 and €4.62, respectively. The RoE of the firm was 11.85 per cent and the share price is €99.63. How would you
Mallory plc has two different bonds currently outstanding. Bond M has a face value of £20,000 and matures in 20 years. The bond makes no payments for the first 6 years, then pays £1,200 every 6
Consider four different equities, all of which have a required return of 15 per cent and a most recent dividend of £4.00 per share. Equities W, X and Y are expected to maintain constant growth rates
Most corporations pay semi-annual rather than annual dividends on their equity. Barring any unusual circumstances during the year, the board raises, lowers or maintains the current dividend once a
Nakamura has earnings of £10 million and is projected to grow at a constant rate of 5 per cent forever because of the benefits gained from the learning curve.Currently all earnings are paid out as
Michelin’s share price is €56.99. You wish to value the company’s equity and compare your valuation to the share price. The dividend that has just been paid is €1.78 and the earnings per
1. Kalvin SA pays dividends that are expected to grow at 7 per cent each year. These will stop in year 5, at which point the company will pay out all its earnings as dividends. Next year’s dividend
For these problems, use any web service that provides financial information. Good examples are Yahoo! Finance, Hemscott, Reuters and FT.com. You can also go to the company’s website and download
What is meant by a project’s NPV, and what is the decision rule? List the main strengths of the net present value method. What do you think are the weaknesses of NPV in practical capital budgeting
What is a project’s payback period? Discuss the advantages and disadvantages of the payback period method. If a project has a payback period less than the lifetime of the project, can we know for
Why would a manager use discounted payback period? Can the discounted payback ever be longer than the conventional payback?
Average accounting return is a popular method with accountants. Review the main strengths and weaknesses of the methodology for practical capital budgeting.
In many countries, internal rate of return is the most popular capital budgeting technique, yet in almost all academic textbooks, NPV is put forward as the best method. Why do you think this is the
Review the main problems that arise when one uses only IRR to evaluate potential projects. In spite of these pitfalls, why do many managers use IRR instead of NPV to evaluate projects?
What is the profitability index, and how is it calculated? Discuss the main applications of the profitability index in capital budgeting. When is it most useful and what are its weaknesses? What is
Why do you think certain capital budgeting techniques are used more often in some countries than in others? If NPV is theoretically the best methodology and most managers of large European
Shire plc has the following mutually exclusive projects.(a) Suppose Shire’s payback period cut-off is 2 years. Which of these two projects should be chosen?(b) Suppose Shire uses the NPV rule to
Which of the following statements is correct:(a) The NPV and the IRR always result in the same accept/reject decisions.(b) The NPV cannot rank mutually exclusive projects.(c) The IRR cannot rank
A project has annual cash flows of -€45,000, €35,000, €15,000 and €5,000. What is the payback period for this project? What is the maximum discount rate that would result in a positive NPV?
An investment project has annual cash inflows of£20,000, £35,400, £48,000 and £54,500, and a discount rate of 14 per cent. What is the discounted payback period for these cash flows if the
Your firm is considering purchasing a machine which requires an annual investment of €16,000. Depreciation is calculated using 20 per cent reducing balance (i.e. instead of depreciating the machine
Vedanta Resources has invested £8 million in a new mining project lasting 3 years. Depreciation is charged on a straight line basis to zero over the course of the project. The project generates
Calculate the NPV of the following project for discount rates of 5, 12 and 19 per cent. Year Cash flow 0 -77,000 +55,000 2 +320,000
Marielle Machinery Works is considering a project which has an initial investment of £10,000 and has expected cash flows of £0 in year 1, £7,500 in year 2, and£8,500 in year 3. The company uses
What is the profitability index for a project with an initial investment of €14,000, and has cash flows of €7,300 in year 1, €6,900 in year 2, and €5,700 in year 3? Should the project be
Suppose the following two independent investment opportunities are available to Greenplain Ltd. The appropriate discount rate is 10 per cent.(a) Compute the profitability index for each of the two
Suppose you are offered £5,000 today but must make the following payments:(a) What is the IRR of this offer?(b) If the appropriate discount rate is 10 per cent, should you accept this offer?(c) If
Consider the following cash flows on two mutually exclusive projects for Tomatina Recreation SA. Both projects require an annual return of 15 per cent.(a) If your decision rule is to accept the
Capital Budgeting Tools Consider the following cash flows:(a) What is the payback period for the above project? Assume the cash flows are received continuously throughout each year.(b) If the
Software games company, Avalanche Entertainment, is considering expanding its highly successful online game franchise to the board game or trading card environment. The company has decided that it
Sandy Grey Ltd is in the process of deciding whether or not to revise its line of mobile phones which it manufactures and sells. Their sole market is large corporations and they have not as yet
Pinto plc is considering spending €10,000 on insulating its office, which will save it €1,000 per year in heating expenses in perpetuity.(a) What is the NPV of the investment when the cost of
The treasurer of Amaro Canned Fruits has projected the cash flows of projects A, B and C as follows.Suppose the relevant discount rate is 12 per cent a year.(a) Compute the profitability index for
Consider the following cash flows of two mutually exclusive projects for Tadcaster Rubber Company. Assume the discount rate for Tadcaster Rubber Company is 10 per cent.(a) Based on the payback
A project has an initial cost of I, has a required return of R, and pays C annually for N years.(a) Find C in terms of I and N such that the project has a payback period just equal to its life.(b)
You are a senior manager at Airbus and have been authorized to spend up to €200,000 for projects. The three projects you are considering have the following characteristics:Assume the corporate
The financial manager of Solsken is evaluating a proposal to purchase a new solar machine unit that has a lifetime of 10 years. The new machine would allow the company to make cost savings of SKr4
An investment under consideration has a payback of 7 years and a cost of £483,000. If the required return is 12 per cent, what is the worst-case NPV? What is the best-case NPV? Explain. Assume the
Yuvhadit Ltd wants to set up a private cemetery business. According to the CFO, Barry M. Deep, business is ‘looking up’. As a result, the cemetery project will provide a net cash inflow of
Moshi Mining is set to open a gold mine in northern Tanzania. The mine will cost 6 million rand to open and will have an economic life of 12 years. It will generate a cash inflow of 1 million rand at
You are out having dinner with your two colleagues who are also studying finance. John, who loves the IRR method, tells you that ranking projects by IRR is fine as long as each project’s cash flows
Many companies have a set of appraisal methods that they recommend their managers use when considering new project investments. Assume that your company uses three methods: NPV (hurdle rate of 20 per
Kikmaheedin Ltd has a project with the following cash flows:What is the IRR of the project? What is happening here? Year 0 012 Cash Flow () 20,000 -26,000 13,000
1. Assume you are the new financial manager of the bed mattress firm, Fairy Tale Lullaby Ltd. The firm has always used payback period and accounting rate of return to appraise new investments. With
Dick Davies, the owner of Davies Gold Mining, is evaluating a new gold mine in Tanzania.Barry Koch, the company’s geologist, has just finished his analysis of the mine site. He has estimated that
In recent years, many firms have experienced significant difficulties in running their operations. This has primarily been down to the stagnant global economic environment, but is also a result of
Why is it important for the financial analyst to focus on incremental cash flows? Which of the following should be treated as an incremental cash flow when computing the NPV of an investment?(a) A

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