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essentials corporate finance

Questions and Answers of Essentials Corporate Finance

Factor Models The UK is found to have two factors, GDP growth and the inflation rate, that generate the returns of all equities. The expected GDP growth rate in the next year is 2 per cent and the
APT There are two equity markets, each driven by the same common force F with an expected value of zero and standard deviation of 10 per cent. There are many securities in each market; thus you can
APT Assume that the following market model adequately describes the return-generating behaviour of risky assets:R it = α i  +  β i R Mt  +  ε it Here:Rit = the return for the ith asset at
APT Assume that the returns of individual securities are generated by the following two-factor model:R it = E ( R it )  +  β ij F 1t  +  β i2 F 2t Here:Rit is the return for security i at
Factor Models The returns on Ericsson, Electrolux and Swedbank are generated as follows:R it = α i  +  β i,SMB R SMB  +  β i,HML,RHML  +  ε it Name α(%) βHML βSMB Ericsson 3 1.2
Factor Models Prove that the portfolio-weighted average of a security’s sensitivity to a particular factor is the same as the covariance between the return of the portfolio and the factor divided
Factor Models How can the return on a portfolio be expressed in terms of a factor model? What is the minimum number of factors needed to explain the expected returns of a group of five securities if
Factor Models Consider the following two-factor model for the returns of three securities. Assume that the factors and epsilons have means of zero. Also, assume the factors have variances of 0.1 and
Factor Models A portfolio manager wants to create a simple portfolio from only two stocks, A and B.The returns for stocks A and B are given by the following equations:R A = 0.09 − 1 F INF
The expected return on an asset having zero betas (with respect to both factors) is 0.03. According to the APT, what are the approximate equilibrium returns on each of the two equities? (25
Discuss what the theoretical results in the APT say about the number of factors used in this question.(25 marks)Assume a two-factor APT model is appropriate for asset returns, and there are an
The APT expected return relationship looks very similar to the security market line that was derived in the capital asset pricing model. Review the differences between the APT and CAPM. (25
You determine that there are two factors under the APT that affect the portfolios you have constructed for your limited clientele, who invest only in gold equities: the rate of inflation and the
For a large-company equity mutual fund, would you expect the betas to be positive or negative for each of the factors in a Fama–French (2016) multifactor model?Dawn Browne, an investment broker,
The SMB, HML, RMW, CMA factors, and risk-free rates for the USA are available at Ken French’s website:mba.tuck.dartmouth.edu/pages/faculty/ken.french/. Download the monthly factors and save the
What do you observe about the beta coefficients for the different mutual funds? Comment on any similarities or differences.Dawn Browne, an investment broker, has been approached by client Jack Thomas
If the market is efficient, what value would you expect for alpha? Do your estimates support market efficiency?Dawn Browne, an investment broker, has been approached by client Jack Thomas about the
Which fund has performed best considering its risk? Why?Dawn Browne, an investment broker, has been approached by client Jack Thomas about the risk of his investments. Dawn has recently read several
NPV, Sensitivity Analysis, Break-even Analysis, and Scenario Analysis ‘NPV is just a tool and as with any tool, it can be dangerous in the wrong hands.’ Discuss this statement. In what way do
Monte Carlo Simulation Explain the rationale underlying Monte Carlo simulation. How does it improve upon other forms of sensitivity analysis? Does it have any weaknesses? If so, what are they? How
Real Options When Apple launched its smartwatch, the NPV from the project was negative. However, the company proceeded with the project. Why do you think this was?
Decision Trees When should you stop decision tree analysis on a capital budgeting project? Explain using an example.REGULAR
Sensitivity Analysis and Break-even Point A retail clothing firm is evaluating the development of a new range of all-weather coats. These coats contain an internal solar battery to provide heating
Scenario Analysis A retail clothing firm is evaluating the development of a new range of all-weather coats. These coats contain an internal solar battery to provide heating whenever the garment is
Financial Break-even L.J.’s Toys has just purchased a £200,000 machine to produce toy cars. The machine will be fully depreciated using 20 per cent reducing balances over its five-year economic
Option to Wait Your company is deciding whether to invest in a new machine. The new machine will increase cash flow by €280,000 per year. You believe the technology used in the machine has a
Decision Trees Ang Electronics has developed a new wearable ring that continually checks blood pressure during the day. If the ring is successful, the present value of the payoff (when the product is
Option to Wait Versus Immediate Investment Global Investments has hired you as a financial consultant to advise them on whether to enter the shoe market, an investment opportunity that has an initial
Decision Trees B&B has a new baby powder ready to market. If the firm goes directly to the market with the product, there is only a 55 per cent chance of success. However, the firm can conduct
Financial Break-even Analysis You are considering investing in a company that cultivates truffles for sale to local restaurants. Use the following information:Sales price per truffle £100.00
Scenario Analysis You have been given the following figures to assess the viability of a new portable hospital scanner. It is expected you will be able to capture 10 per cent of the total market of
Break-even Intuition Consider a project with a required return of R per cent that costs £I and will last for N years. The project uses straight-line depreciation to zero over the N-year life; there
Project Analysis You are considering a new product launch. The project will cost £460,000, have a four-year life and have no salvage value; depreciation is 20 per cent reducing balance. Sales are
Project Analysis McGilla Golf has decided to sell a new line of golf clubs. The clubs will sell for£700 per set and have a variable cost of £320 per set. The company has spent £150,000 for a
Decision Trees Young screenwriter Carl Draper has just finished his first script. It has action, drama and humour, and he thinks it will be a blockbuster. He takes the script to every film studio in
Accounting Break-even Samuelson GmbH has just purchased a €600,000 machine to produce calculators.The machine will be fully depreciated using the 20 per cent reducing balance method over its
Real Options Petrofac Ltd, the international provider of oil and gas building facilities, has entered into an agreement with a number of Kenyan oil exploration firms to support development of oil
Abandonment Decisions Allied Products is considering a new product launch. The firm expects to have an annual operating cash flow of AED60 million for the next six years. Allied Products uses a
Expansion Decisions Applied Nanotech is thinking about introducing a new surface cleaning machine.The marketing department has come up with the estimate that Applied Nanotech can sell 10 units per
Scenario Analysis You are the financial analyst for a tennis racket manufacturer. The company is considering using a graphite-like material in its tennis rackets. The company has estimated the
The Capital Budgeting Process This question takes a step back from the quantitative analysis and makes you think about how you would manage a capital budgeting project in a firm. You have just
Scenario Analysis Consider a project to supply Italy with 40,000 tons of machine screws annually for automobile production. You will need an initial €1,500,000 investment in threading equipment to
Abandonment Decisions Consider the following project for Hand Clapper. The company is considering a four-year project to manufacture clap-command garage door openers. This project requires an initial
Abandonment Decisions M.V.P. Games has hired you to perform a feasibility study of a new video game that requires a $9 million initial investment. M.V.P. expects a total annual operating cash flow of
Financial Break-even The Wheatchopper Company is considering the purchase of a new harvester.Wheatchopper has hired you to determine the break-even purchase price in terms of present value of the
Sensitivity Analysis Unmondo SpA is proposing to replace its manufacturing machinery with more modern equipment geared towards 3D printing. The new machinery costs €9 million (the existing
Option to Abandon You own an unused gold mine that will cost $800,000 to reopen. If you open the mine, you expect to be able to extract 1,000 ounces of gold a year for each of three years. After
Options to Abandon and Expand Grace and Danger plc is introducing a new product this year. If its luminous golf balls (with integrated beeper) are a success, the firm expects to be able to sell
You are the financial analyst for Weir Group plc, the global engineering firm. The company is considering the development of a new slurry pump in its existing products. The pump is expected to
Explain the difference between sensitivity analysis, scenario analysis and break-even analysis. In the context of the problem in Part 1, what do you think is the most appropriate investment appraisal
Bunyan Lumber Ltd harvests timber and delivers logs to timber mills for sale. The company was founded 70 years ago by Pete Bunyan. The current CEO is Paula Bunyan, the granddaughter of the founder.
Let us return to the cement Practical Case Study from Chapter 7. The executives of the cement company have decided to go ahead with the investment appraisal and have retained you for the more
Valuation: The Multi-period Case You have taken out a loan that requires annual payments of £110 for each of the next two years. You wish to pay back the loan over four years. Should the payment be
What is a Firm Worth? What is discounted cash flow (DCF) valuation? Can it be used to estimate the value of companies? What businesses could we value using DCF valuation? What are the advantages and
Interest You work for jewellers and have sourced a good goldsmith who is able to sell you 100 ounces of gold for £100,000. You approach your two main customers. Mr Noel says he will buy the gold
Calculating APR Find the APR for the following five-year loan: a principal of £15,000 with a stated annual interest rate of 7 per cent on the original principal amount to be paid in 60 monthly
Future Value What is the future value in four years of €1,000 invested in an account with a stated annual interest rate of 10 per cent,(a) Compounded annually(b) Compounded semi-annually(c)
Growing Perpetuities Oasis Healthtec has been working on a ring that measures blood pressure, heart rate variability and heart rate continuously when worn. It is charged through kinetic energy.The
Unusual Perpetuities You have invested in a project that will pay you £1,000 every two years. If the interest rate is 8 per cent, how much is the project worth today?
Calculating Present Values A three-year annuity of six £5,000 semi-annual payments will begin 10 years from now, with the first payment coming 10.5 years from now. If the discount rate is 10 per
Balloon Payments On 1 September 2018, Susan Chao bought a motorcycle for £15,000. She paid £1,000 down and financed the balance with a five-year loan at a stated annual interest rate of 9.6 per
Calculating Annuity Values You are serving on a jury. A plaintiff is suing the city for injuries sustained after a freak doggie poo accident. In the trial, doctors testified that it will be five
You have just started a new company to deliver mail and parcels to rural communities. At the moment, other companies either do not provide a service or are exceptionally expensive. The new company
You want to pay off the van loan completely and contact your bank for details. The bank has indicated that early completion of your loan will incur a 1 per cent penalty. You have just paid an
Explain how you would modify the present value of an annuity shortcut formula to accommodate an equal payment stream that begins immediately. How would you change the present value of an annuity
How does Max’s age affect his decision to get an MBA?Max Gruber graduated from university six years ago with a finance undergraduate degree. Although he is satisfied with his current job, his goal
What other, perhaps non-quantifiable, factors affect Max’s decision to get an MBA?Max Gruber graduated from university six years ago with a finance undergraduate degree. Although he is satisfied
Assuming all salaries are paid at the end of each year, what is the best option for Max – from a strictly financial standpoint?Max Gruber graduated from university six years ago with a finance
Max believes that the appropriate analysis is to calculate the future value of each option. How would you evaluate this statement?Max Gruber graduated from university six years ago with a finance
What initial salary would Max need to receive to make him indifferent between attending Universität des Geschäfts and staying in his current position?Max Gruber graduated from university six years
Suppose, instead of being able to pay cash for his MBA, Max must borrow the money. The current borrowing rate is 5.4 per cent. How would this affect his decision?Max Gruber graduated from university
In Yahoo! Finance, find the closing price for a company in your country. Find the price exactly four years before. What was your annual return over the last four years assuming you purchased the
Find the share price for a company in your country by visiting Yahoo! Finance. You find an analyst who projects the share price will increase 12 per cent per year for the foreseeable future. Based on
Definition of a Bond What are the main characteristics of a bond? Provide examples of different types of bonds in terms of coupons, maturity and face value.
Bond Valuation 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?
Bond Concepts Explain the difference between a coupon rate and a yield to maturity. Show, using examples, how changing the coupon rate and yield to maturity affect the bond price.
The Present Value of Equity Explain why the share price depends on dividends and capital gains.
The Dividend Growth Model Under what two assumptions can we use the dividend growth model to determine the share price? Comment on the reasonableness of these assumptions.
Growth Opportunities 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?
Net Present Value of Growth Opportunities Explain what is meant by NPVGO. In what circumstances is calculating the NPVGO better than other methods of share valuation?
Price–Earnings Ratio 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
Stock Market Reporting What information might a financial analyst need when valuing a company’s prospects? Comment on the usefulness of this information.
Firm Valuation Explain how you would undertake a multiples valuation. Is this approach consistent with other valuation models that use discounted cash flow? Explain.REGULAR
Valuing Bonds 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)
Share Values 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:Stock A Stock B Return on equity 15%
Share Values 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
Share Values 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
Growth Opportunities If your company 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
Equity Valuation 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 for ever. Investors in XYZ require a rate of
Bond Price Movements Define each of the following terms:(i) Treasury bill(ii) Pure discount bond(iii) Index-linked bond.
Bond Returns The UK government issues a five-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
Valuing Preference Shares Mark Bank has just issued some new preference shares. The issue will pay a£5 annual dividend in perpetuity, beginning four years from now. If the market requires an 8 per
Non-constant Growth 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
Semi-annual Dividends The Belgian food group Delhaize has just paid a dividend of €1.08. If the annual discount rate on Delhaize shares is 8 per cent and the dividend is expected to grow at 3 per
Finding the Required Return 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
Price–Earnings Ratio The market consensus is that Pinto plc has an ROE of 9 per cent and plans to maintain its plowback ratio of 0.67. This year’s earnings per share was €3. The discount rate
Growth Opportunities For Pinto plc in question 24 above, what is the present value of growth opportunities?
Firm Valuation The ABC plc statement of cash flows 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
Growth Opportunities 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
Firm Valuation Your company’s net income was €4.456 million, EPS was €73.56 and the dividend payout ratio was 23.7 per cent. The return on equity of the firm was 17.83 per cent and its debt to

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