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essentials corporate finance

Questions and Answers of Essentials Corporate Finance

Components of Bond Returns 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
Discount Rate Wonte is a German commercial vehicle manufacturer. Its DPS and EPS for last year were€2 and €4.62, respectively. The ROE of the firm was 11.85 per cent and the share price is
Valuing Bonds 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 six years, then pays
Equity Valuation 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
Growth Opportunities Nakamura has earnings of £10 million and is projected to grow at a constant rate of 5 per cent for ever because of the benefits gained from the learning curve. Currently all
Equity Valuation Rando’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
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 is
If Kalvin SA were to distribute all its earnings, it could maintain a level dividend stream of €15 per share.How much is the market actually paying per share for growth opportunities? (20 marks)
A six-year government bond makes annual coupon payments of 4 per cent and offers a yield of 8 per cent annually compounded. Suppose that, one year later, the bond still yields 8 per cent. What return
How would you value a firm that pays no dividends? Explain, using a quantitative example to illustrate your answer. (40 marks)
Assuming Ecorenewable Energy continues its current growth rate, what is the share price of the company’s equity?Ecorenewable Energy is a renewable wave energy firm that was established in 2016 by
You have been hired to verify the share price valuation, and have been given information on Ecorenewable Energy and its three closest competitors. You believe that although Ecorenewable Energy has a
What is the industry average price–earnings ratio? What is Ecorenewable Energy’s price–earnings ratio? Comment on any differences and explain why they may exist.Ecorenewable Energy is a
Assume the company’s growth rate declines to the industry average after five years. What percentage of the equity’s value is attributable to growth opportunities?Ecorenewable Energy is a
Assume the company’s growth rate slows to the industry average in five years. What future return on equity does this imply?Ecorenewable Energy is a renewable wave energy firm that was established
Both shareholders of Ecorenewable Energy wish to increase the value of the company equity but want to retain control of the company. They will not sell shares to outside investors and believe the
Dividend Discount Model Choose any large company from your country and download its most recent statement of financial position and statement of profit and loss. Using the financial figures in the
Growth Opportunities Assume that investors require an 8 per cent return on the company you studied for question 1. Using this share price and the EPS for the most recent year, calculate the NPVGO for
Net Present Value 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
Payback Period 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,
Discounted Payback Period Why would a manager use discounted payback period? Can the discounted payback ever be longer than the conventional payback?
Average Accounting Return Average accounting return is a popular method with accountants. Review the main strengths and weaknesses of the methodology for practical capital budgeting.
Internal Rate of Return 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
Problems with IRR 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
Profitability Index 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
MIRR In which situations would you use MIRR instead of IRR? Explain your answer using a practical example.
Margin of Safety Although margin of safety is used by many investors, explain the method’s major criticisms. Do you agree with these? Explain.10 The Practice of Capital Budgeting Why do you think
Calculating Payback Period and NPV Shire plc has the following mutually exclusive projects:Year Project A (£) Project B (£)0 –14,000 –6,000 1 4,000 4,500 2 5,500 2,200 3 8,000 200(a) Suppose
Investment Criteria 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
Discounted Payback and Discount Rates 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
Average Accounting Return Your firm is considering purchasing a machine that requires an annual investment of €16,000. Depreciation is calculated using 20 per cent reducing balance (i.e. instead of
Average Accounting Return Vedanta Resources has invested £8 million in a new mining project lasting three years. Depreciation is charged on a straight-line basis to zero over the course of the
Calculating NPV Calculate the NPV of the following project for discount rates of 5, 12 and 19 per cent.Year 0 1 2 Cash flow −£77,000 +£55,000 +£320,000
Calculating IRR and MIRR Marielle Machinery Works is considering a project that has an initial investment of £10,000 and expected cash flows of £0 in year 1, £7,500 in year 2 and £8,500 in year
Calculating Profitability Index What is the profitability index for a project with an initial investment of€14,000, which has cash flows of €7,300 in year 1, €6,900 in year 2 and €5,700 in
Calculating Profitability Index Suppose the following two independent investment opportunities are available to Greenplain Ltd. The appropriate discount rate is 10 per cent.(a) Compute the
Problems with IRR Suppose you are offered £5,000 today but must make the following payments:Year Cash Flows (£)0 5,000 1 –2,500 2 –2,000 3 –1,000 4 –1,000(a) What is the IRR of this
NPV versus IRR Consider the following cash flows on two mutually exclusive projects for Tomatina Recreation SA. Both projects require an annual return of 15 per cent.Year Deepwater Fishing (€) New
Capital Budgeting Tools Consider the following cash flows:Year 0 1 2 3 4 5 Cash flow −£15,000 £4,000 £5,000 −£2,000 £7,000 £7,000(a) What is the payback period for the above project? Assume
Comparing Investment Criteria Software games company Avalanche Entertainment is considering expanding its highly successful online game franchise to the board game or trading card environment. The
Capital Budgeting Sandy Grey Ltd is in the process of deciding whether or not to revise its line of mobile phones, which it manufactures and sells. Its sole market is large corporations and it has
Comparing Investment Criteria 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
Comparing Investment Criteria The treasurer of Amaro Canned Fruits has projected the cash flows of projects A, B and C as follows.Year Project A (€) Project B (€) Project C (€)0 −100,000
Comparing Investment Criteria 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
Comparing Investment Criteria 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
Project Valuation 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
Payback and NPV An investment under consideration has a payback of seven 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
Multiple IRRs This problem is useful for testing the ability of financial calculators and computer software. Consider the following cash flows. How many different IRRs are there? (Hint: Search
Calculating IRR 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
IRR and NPV 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
Investment Appraisal 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
Calculating Incremental Cash Flows Darin Clay, the CFO of MakeMoney.com, has to decide between the following two projects:
Multiple IRRs This problem is useful for testing the ability of financial calculators and computer software. Consider the following cash flows. How many different IRRs are there? (Hint: Search
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 your
A solar panel production firm, Soleil SA, is considering an investment in new solar production technology.The new investment would require initial funding of €4 million today and further
Construct a spreadsheet to calculate the payback period, internal rate of return, modified internal rate of return and net present value of the proposed mine.You have set up a new firm in Copenhagen
Based on your analysis, should the company open the mine?You have set up a new firm in Copenhagen to produce mobile face recognition technology for all new smartphones. An opportunity has arisen that
Bonus question: Most spreadsheets do not have a built-in formula to calculate the payback period. Write a macro that calculates the payback period for a project.You have set up a new firm in
Use NPV and other capital budgeting theories to explain the reasoning behind its restructuring.
Is it possible for the value of distressed firms’ shares to go up even though their sales revenues are extremely likely to fall as a result of their decisions? Explain your answer.
What do you think would be the effect of your firm’s business decisions on its risk? How would this factor into the value of your company’s operations?
Can you think of any other business decisions your company could have made to protect itself against future economic conditions? Give some reasons why you think it did not choose these.
Look up the share price of your firm and search the internet (FT.com, Yahoo! Finance, Reuters, Google News are examples) for information on your company over the last three years. What was the main
Returns What is meant by the term ‘return’? What is the difference between monetary returns and percentage returns? Do monetary or percentage returns matter more to investors? Provide an example
Holding Period Returns In what situations would you use a holding period return or a percentage return? Are the two measures the same?
Return Statistics Why would you wish to present return distributions? How do you think the distributions would change when you incorporated inflation into the return statistics?
Risk Statistics What do we mean by risk? In long-term investments, equities tend to give higher returns than bonds. Why, then, do all investors not invest in equities? Are such investors irrational?
Other Return Measures What is the difference between arithmetic and geometric returns? Suppose you have invested in a company’s shares for the last 10 years. Which number is more important to you,
Investment Selection Given that the Ukraine Stock Exchange was up by over 80 per cent in 2018, why didn’t all investors put their money in Ukraine?
Investment Selection Given that the Venezuela stock exchange was down 94.9 per cent in 2018, why did investors continue to hold shares in Venezuela? Why didn’t they sell out before the market
Equities versus Gambling Critically evaluate the following statement: ‘Investing in the stock market is just like gambling. It has no social value and investors do it purely to give them a
Returns Two years ago, General Materials’ and Standard Fixtures’ share prices were the same. During the first year, General Materials’ share price increased by 10 per cent while Standard
Historical Returns The historical returns presented in the chapter are not adjusted for inflation. What would happen to the estimated risk premium if we did account for inflation? The returns are
Calculating Returns and Variability The returns of Lockhart Group plc and TJC plc are given below.Using the following returns, calculate the average returns, the variances and the standard deviations
Risk Premiums Refer to Table 9.1 and look at the period 2008–2018.(a) Calculate the arithmetic average returns for each country’s stock market over this period.(b) Calculate the standard
Calculating Returns and Variability You have observed the following prices for British Auto, the luxury car maker, for a number of years. Jan 2011: €26.87; Jan 2012: €35.19; Jan 2013: €32.17;
Calculating Real Returns and Risk Premiums In Problem 15, suppose the average inflation rate over this period was 4.2 per cent and the average T-bill rate over the period was 5.1 per cent.(a) What
Holding Period Return A firm had the following share prices: Jan 2015: £1.12; Jan 2016: £1.34; Jan 2017:£1.68; Jan 2018: £1.8825; Jan 2019: £2.18; Jan 2020: £2.07. The equity paid no dividends.
Return Distributions Refer back to Table 9.3. What range of risk premiums would you expect to see 68 per cent of the time for Europe? What about 95 per cent of the time?
Blume’s Formula Over a 30-year period an asset had an arithmetic return of 12 per cent and a geometric return of 10 per cent. Using Blume’s formula, what is your best estimate of the future
Arithmetic and Geometric Returns An equity has had returns of 10 per cent, 15 per cent, 20 per cent,–12 per cent, 2 per cent, and –5 per cent over the last six years. What are its arithmetic and
Using Return Distributions Assume that the returns from holding French shares are normally distributed. From Table 9.2, what is the approximate normal distribution probability that your money will
Using Return Distributions Suppose the mean returns on long-term government bonds are 5.8 per cent, and are normally distributed with a standard deviation of 9.3 per cent. Based on the historical
Distributions Your investment portfolio has earned returns of 400 per cent once in the last 10 years, zero per cent in 8 years out of the last 10 years and lost 90 per cent one year. What was the
Inflation The inflation rates for the UK have been as follows, 2018: 2.5 per cent; 2017: 2.7 per cent; 2016:0.7 per cent; 2015: 0 per cent; and in 2014: 1.5 per cent. Calculate the average real
Calculating Returns Go to the Yahoo! Finance website and look up any FTSE 100 company of your choice. Click on the Historical Prices link. Find its closing price yesterday and its closing price
Value at Risk The monthly prices for Banco Ruida are as follows:Date Adj Close 01/03/2020 514.2 01/02/2020 518 03/01/2020 493.35 01/12/2019 492.75 01/11/2019 473 03/10/2019 533 01/09/2019 539
Calculate the average arithmetic returns, the variances and the standard deviations for Mauritius. (30 marks)You have invested in the Mauritian stock market. Details on the performance of the market
Calculate the geometric return on the Mauritius Stock Market and compare it to the arithmetic return.Comment on and explain the differences between the Mauritius arithmetic and geometric return. (20
What was the holding period return on Mauritius equities over the period? (10 marks)You have invested in the Mauritian stock market. Details on the performance of the market are given below:Date
Suppose the returns on Mauritius equities are normally distributed. Based on the data above, what is the approximate probability that your return on these will be less than –2 per cent in a given
Review the difficulties in using historical data to measure expected returns on an investment. (20 marks)You have invested in the Mauritian stock market. Details on the performance of the market are
Calculating Yields Download the historical monthly share prices for a company of your choice from Yahoo! Finance. Find the closing share price for yesterday and for exactly two years ago. The
Calculating Average Returns Download the Monthly Adjusted Share Prices for a company of your choice. What is the return on the equity over the past 12 months? Now use the 1 Month Total Return and
What advantages do the mutual funds offer compared to the company equity?You recently graduated from university, and your job search led you to West Coast Yachts at Kip Marina.Because you felt the
Assume that you invest 5 per cent of your salary and receive the full 5 per cent match from West Coast Yachts. What APR do you earn from the match? What conclusions do you draw about matching
Assume you decide you should invest at least part of your money in large-capitalization companies based in the United Kingdom. What are the advantages and disadvantages of choosing the Skandla
The returns on the Skandla Small-Cap Fund are the most volatile of all the mutual funds offered in the retirement plan. Why would you ever want to invest in this fund? When you examine the expenses
A measure of risk-adjusted performance that is often used is the Sharpe ratio. The Sharpe ratio is calculated as the risk premium of an asset divided by its standard deviation. The standard deviation
What portfolio allocation would you choose? Why? Explain your thinking carefully.You recently graduated from university, and your job search led you to West Coast Yachts at Kip Marina.Because you

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