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fundamentals corporate finance

Questions and Answers of Fundamentals Corporate Finance

Effective interest rate: The Kellogg Bank requires borrowers to keep an 8 percent compensating balance. Gorman Jewels borrows$340,000 at a 7 percent stated APR. What is the effective interest rate on
Lockbox: Pacific Traders has annual sales of $1,895,000.The firm’s financial manager has determined that using a lockbox will reduce collection time by 2.3 days. If the firm’s opportunity cost on
Lockbox: Rosenthal Design has daily sales of $59,000. The financial management team has determined that a lockbox would reduce the collection time by 1.6 days. Assuming the company can earn 5.2
Cost of trade credit: Mill Street Corporation sells its goods with terms of 4/10 EOM, net 60. What is the implicit cost of the trade credit?
Cost of trade credit: Sybex Corp. sells its goods with terms of 2/10 EOM, net 30. What is the implicit cost of the trade credit?
Current asset management strategy: Describe the risks that are associated with a restrictive current asset management strategy.
Operating cycle: NetSpeed Technologies is a telecom component manufacturer. The firm typically has a collection period of 44 days and days’ sales in inventory of 29 days. What is the operating
Operating cycle: Lilly’s Bakery distributes its products to more than 75 restaurants and delis. The company’s average collection period is 27 days, and it keeps its inventory for an average of
Cash conversion cycle: Devon Automotive management estimates that it takes the company 62 days to collect cash from customers on finished goods from the day it receives raw materials, and it takes 65
Cash conversion cycle: Northern Manufacturing Company management found that during the last year it took an average of 47 days to pay its suppliers, whereas it took 63 days to collect its
Cash conversion cycle: Wolfgang’s Masonry management estimates that it takes the company 27 days on average to pay its suppliers.Management also knows that the company has days’ sales in
Suppose the cost of capital of the Gadget Company is 10 percent. If Gadget has a capital structure that is 50 percent debt and 50 percent equity, its before-tax cost of debt is 5 percent, and its
The Gearing Company has an after-tax cost of debt capital of 4 percent, a cost of preferred stock of 8 percent, a cost of equity capital of 10 percent, and a weighted average cost of capital of 7
Morgan Insurance Ltd. issued a fixed-rate perpetual preferred stock three years ago and placed it privately with institutional investors.The stock was issued at $25.00 per share with a $1.75
Dot.Com has determined that it could issue $1,000 face value bonds with an 8 percent coupon paid semiannually and a five-year maturity at $900 per bond. If Dot.Com’s marginal tax rate is 30
The CFO described in Problem 13.35 asks you to estimate the beta for Coral Gables’ common stock. Since the common stock is not publicly traded, you do not have the data necessary to estimate the
You are working as an intern at Coral Gables Products, a privately owned manufacturing company. Shortly after you read Chapter 13 in this book, you got into a discussion with the chief financial
Hurricane Corporation is financed with debt, preferred equity, and common equity with market values of $20 million, $10 million, and $30 million, respectively. The betas for the debt, preferred
You know that the return of Momentum Cyclicals’ common shares is 1.6 times as sensitive to macroeconomic information as the return of the market. If the risk-free rate of return is 3.50 percent
Choosing a discount rate: If a firm’s management anticipates financing a project with a capital mix that is different from its current capital structure, describe how the firm is subjecting itself
Choosing a discount rate: For the Imaginary Products firm in Problem 13.24, calculate the appropriate cost of capital for a new project that is financed with the same proportion of debt, preferred
WACC: The Imaginary Products Co. currently has debt with a market value of $300 million outstanding. The debt consists of 9 percent coupon bonds (semiannual coupon payments) that have a maturity of
Cost of common stock: You have calculated the cost of common stock using all three methods described in this chapter. Unfortunately, all three methods have yielded different answers. Describe which
Cost of common stock: Write out the general equation for the price of the stock for a firm that will grow dividends very rapidly at a constant rate for the four years after the next dividend is paid
Cost of common stock: Underestimated Inc.’s common shares currently sell for $36 each. The firm’s management believes that its shares should really sell for $54 each. If the firm just paid an
Cost of debt for a firm: You are analyzing the after-tax cost of debt for a firm. You know that the firm’s 12-year maturity, 9.5 percent semiannual coupon bonds are selling at a price of $1,200.
Taxes and the cost of debt: Holding all other things constant, does a decrease in the marginal tax rate for a firm provide incentive for the managers of a firm to increase or decrease its use of debt?
Current cost of a bond: You are analyzing the cost of debt for a firm. You know that the firm’s 14-year maturity, 8.5 percent coupon bonds are selling at a price of $823.48. The bonds pay interest
Current cost of a bond: Perpetual Ltd. has issued bonds that never require the principal amount to be repaid to investors. Correspondingly, Perpetual must make interest payments into the infinite
Current cost of a bond: You know that the after-tax cost of debt capital for Bubbles Champagne Company is 7 percent. If the firm has only one issue of five-year bonds outstanding, what is the current
Finance balance sheet: Explain why the cost of capital for a firm is equal to the expected rate of return to the investors in the firm.
Finance balance sheet: Explain why the total value of all of the securities used to finance a firm must be equal to the value of the firm.
WACC: What are direct out-of-pocket costs?
WACC: Capital Co. has a capital structure, based on current market values, that consists of 50 percent debt, 10 percent preferred stock, and 40 percent common stock. If the returns required by
WACC: Describe the alternatives to using a firm’s WACC as a discount rate when evaluating a project.
Cost of preferred stock: Kresler Autos has preferred shares outstanding that pay annual dividends of $12, and the current price of the shares is $80. What is the after-tax cost of new preferred
Cost of preferred stock: Fjord Luxury Liners has preferred shares outstanding that pay an annual dividend equal to $15 per year.If the current price of Fjord preferred shares is $107.14, what is the
Cost of common stock: Two-Stage Rocket paid an annual dividend of $1.25 yesterday, and it is commonly known that the firm’s management expects to increase its dividend by 8 percent for the next two
Cost of common stock: Seerex Wok Co. is expected to pay a dividend of $1.10 one year from today on its common shares. That dividend is expected to increase by 5 percent every year thereafter.If the
Cost of common stock: Whitewall Tire Co. just paid an annual dividend of $1.60 on its common shares. If Whitewall is expected to increase its annual dividend by 2 percent per year into the
Cost of common stock: List and describe each of the three methods used to calculate the cost of common stock.
Taxes and the cost of debt: How are taxes accounted for when we calculate the cost of debt?
WACC: What is the weighted average cost of capital for a firm?
Finance balance sheet: KneeMan Markup Company has total debt obligations with book and market values equal to $30 million and $28 million, respectively. It also has total equity with book and market
Present value with multiple cash flows: Biogenesis Inc. management expects the following cash flow stream over the next five years. The company discounts all cash flows using a 23 percent discount
Present value with multiple cash flows: Carol Jenkins, a lottery winner, will receive the following payments over the next seven years. She has been approached by an investor who will pay her a lump
Calculating the variance and standard deviation: Barbara is considering investing in a company’s stock and is aware that the return on that investment is particularly sensitive to how the economy
Calculating the variance and standard deviation: Ben would like to invest in gold and is aware that the returns on such an investment can be quite volatile. Use the following table of states,
Portfolios with more than one asset: Given the returns and probabilities for the three possible states listed below, calculate the covariance between the returns of Stock A and Stock B. For
You have been provided with the following information about the expected returns to Stock A and Stock B for various possible future economic conditions.The market risk premium is 7 percent, and the
The Fulcrum Company produces decorative swivel platforms for home televisions. If Fulcrum produces 40 million units, it estimates that it can sell them for $100 each. The variable production costs
Commodore Motors management is considering a project to produce toy cars. The project would require an initial outlay of$100,000 and have an expected life of 10 years. Management estimates that each
You are working for Eagle Golf Corporation as described in Problem 12.35. A different equipment manufacturer is recommending its “Wedge 2100” club-making machine. The initial cost of the Wedge
If a firm’s costs (both variable and fixed) are known with certainty, then what are the only two sources of volatility for the firm’s operating profits or its operating cash flows?
Mick’s Soft Lemonade is starting to develop a new product for which the cash fixed costs are expected to be $80,000. The projected EBIT is $100,000, and the Accounting DOL is expected to be 2.0.
Scenario analysis: Chip’s Home Brew Whiskey management forecasts that if the firm sells each bottle of Snake-Bite for $20, then the demand for the product will be 15,000 bottles per year. Sales
Sensitivity analysis: Describe the circumstances under which sensitivity analysis might be a reasonable basis for determining changes to a firm’s EBIT or FCF.
Sensitivity and scenario analyses: Sensitivity analysis and scenario analysis are somewhat similar. Describe which is a more realistic method of analyzing the impact of different scenarios on a
Economic break-even point: The BowGus Archery Company management estimates that its new Galactically Flexible Bow project will have to generate EBIT of $20,000 each year to be viable.The project’s
Economic break-even point: Rose Weiser Company management is considering a project that will require an initial investment of $50,000 and will last for 10 years. No other capital expenditures or
Economic break-even point: Management of March and Dine Inc. has estimated that the firm’s new TV dinner project must generate $10,200 in FCF during each of the next six years to have an NPV of $0.
Accounting and cash flow break-even: Your analysis tells you that at a projected level of sales, a project your firm is considering will be below accounting break-even but above cash flow
Pretax operating cash flow break-even: Calculate the pretax operating cash flow break-even point for both factory choices for Dandle’s Candles.
Crossover level of unit sales: Calculate the number of candles for which the accounting operating profit at Dandle’s Candles is the same regardless of the factory choice.
Accounting operating profit break-even: Calculate the accounting operating profit break-even point for both factory choices for Dandle’s Candles.
Cash Flow DOL: For the Vinyl CD Co. in Self-Study Problem 12.3, what percentage increase in pretax operating cash flow will be driven by the additional revenue?
Cash Flow DOL: The pretax operating cash flow of Memphis Motors declined so much during the recession of 2008 and 2009 that the company almost defaulted on its debt. The owner of the company wants to
EBIT: Specialty Light Bulbs management anticipates selling 3,000 light bulbs this year at a price of $15 per bulb. It costs Specialty$10 in variable costs to produce each light bulb, and the fixed
EBIT: Duplicate Footballs, Inc., management expects to sell 15,000 balls this year. The balls sell for $110 each and have a variable cost per unit of $80. Fixed costs, including depreciation and
EBIT: If a manufacturing firm and a service firm have identical cash fixed costs, but the manufacturing firm has much higher depreciation and amortization, then which firm is more likely to have a
Simulation analysis: What is simulation analysis, and how is it used?
Break-even point: The accounting operating profit breakeven point tells us the number of units that must be sold for a firm to break even in a given year from an accounting operating profit
Break-even analysis: Why is the per-unit contribution important in a break-even analysis?
Accounting DOL: Caterpillar, Inc., is a manufacturer of large earth-moving and mining equipment. This firm and other heavy equipment manufacturers have degrees of accounting operating leverage that
Accounting DOL: Explain how the value of the degree of accounting operating leverage can be used.
Cash Flow DOL: The degree of pretax cash flow operating leverage at Rackit Corporation is 2.7 when it sells 100,000 units of its new tennis racket and its EBITDA is $95,000. Ignoring the effects of
EBIT: WalkAbout Kangaroo Shoe Stores management forecasts that it will sell 9,500 pairs of shoes next year. The firm buys its shoes for $50 per pair from the wholesaler and sells them for $75 per
EBIT: The Generic Publications Textbook Company sells all of its books for $100 per book, and it currently costs $50 in variable costs to produce each text. The fixed costs, which include
EBIT: Describe the role that the mix of variable versus fixed costs has in the variation of earnings before interest and taxes (EBIT)for a firm.
Fixed and variable costs: Define variable costs and fixed costs, and give an example of each.
After estimating a project’s NPV, the analyst is advised that the fixed capital outlay will be revised upward by $100,000. The fixed capital outlay is depreciated straight-line over an eight-year
FITCO is considering the purchase of new equipment. The equipment costs $350,000, and an additional $110,000 is needed to install it. The equipment will be depreciated straight-line to zero over a
Paye’s Panes manufactures insulated windowpanes. The company’s CFO has asked you to assess a new manufacturing plant she is considering. The initial cost will be $475,000. While for tax purposes
The alternative to investing in the new production line in Problem 11.36 is to overhaul the existing line, which currently has both a book value and a salvage value of $0. It would cost $300,000 to
ACME Manufacturing management is considering replacing an existing production line with a new line that has a greater output capacity and operates with less labor than the existing line. The new line
Great Fit, Inc., is a company that manufactures clothing. The company has a production line that produces women’s tops of regular sizes. The same machine could be used to produce petite sizes as
A beauty product company is developing a new fragrance named Happy Forever. There is a probability of 0.5 that consumers will love Happy Forever, and in this case, annual sales will be 1 million
Rocky Mountain Lumber, Inc., is considering purchasing a new wood saw that costs $50,000. The saw will generate revenues of $100,000 per year for five years. The cost of materials and labor needed to
Merton Shovel Corporation has decided to bid for a contract to supply shovels to the Honduran Army. The Honduran Army intends to buy 1,000 shovels per year for the next three years. To supply these
You are the CFO of SlimBody, Inc., a retailer of the exercise machine Slimbody6 and related accessories. Your firm is considering opening a new store in Los Angeles. The store will have a life of 20
Replace an existing asset: You are thinking about delivering pizzas in your spare time. Since you must use your own car to deliver the pizzas, you will wear out your current car one year earlier,
When to harvest an existing asset: Anaconda Manufacturing Company currently owns a mine that is known to contain a certain amount of gold. Since Anaconda does not have any gold-mining expertise, the
Replace an existing asset: Assume that you are considering replacing your old Nissan with a new Hyundai, as in the previous problem. However, the annual maintenance cost of the old Nissan increases
Replace an existing asset: You have a 2000 Nissan that is expected to run for another three years, but you are considering buying a new Hyundai before the Nissan wears out. You will donate the Nissan
When to harvest an asset: Predator LLC, a leveragedbuyout specialist, recently bought a company and wants to determine the optimal time to sell it. The partner in charge of this investment has
Projects with different lives: You are starting a family pizza parlor and need to buy a motorcycle for delivery orders. You have two models in mind. Model A costs $9,000 and is expected to run for 6
Projects with different lives: You are trying to choose between purchasing one of two machines for a factory. Machine A costs $15,000 to purchase and has a three-year life. Machine B costs $17,700 to
FCF and NPV for a project: Archer Daniels Midland Company is considering buying a new farm that it plans to operate for 10 years. The farm will require an initial investment of $12 million.This
Cash flows from operations: Given the desire to cut carbon emissions, Ford is considering introducing a new production line of electric sedans. The expected annual unit sales of the electric cars is
Investment cash flows: Healthy Potions, Inc., is considering investing in a new production line for eye drops. Other than investing in the equipment, the company needs to increase its cash and cash

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