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fundamentals corporate finance

Questions and Answers of Fundamentals Corporate Finance

Marginal and average tax rates. MoCo, Inc., operates in a state where companies face a tax rate of 9 percent on taxable income up to $1,000,000 and 10.5 percent on taxable income above
Nominal versus real cash flows: You are graduating in two years. You want to invest your current savings of $5,000 in bonds and use the proceeds to purchase a new car when you graduate. You can
Nominal versus real cash flows: You are buying a sofa. You will pay $200 today and make three consecutive annual payments of $300 in the future. The real rate of return is 10 percent, and the
Projects with different lives: If you had to choose between one project with an expected life of five years and a second project with an expected life of six years, how could you do this without
Replace an existing asset: Explain how we determine the optimal time to replace an existing asset with a new one.
Projects with different lives: Explain the concept of equivalent annual cost and how it is used to compare projects with different lives.
Expected cash flows: Define expected cash flows, and explain why this concept is important in evaluating projects.
Investment cash flows: Keswick Supply Company wants to set up a division that provides copy and fax services to businesses.Customers will be given 20 days to pay for such services. The annual revenue
Investment cash flows: Six Twelve, Inc., is considering opening up a new convenience store in downtown New York City.The expected annual revenue at the new store is $800,000. To estimate the increase
Investment cash flows: Zippy Corporation just purchased computing equipment for $20,000. The equipment will be depreciated using a five-year MACRS depreciation schedule. If the equipment is sold at
Cash flows from operations: When forecasting operating expenses, explain the difference between a fixed cost and a variable cost.
Cash flows from operations: What are variable costs and fixed costs? What are some examples of each? How are these costs estimated in forecasting operating expenses?
Computing terminal-year FCF: Healthy Potions, Inc., a pharmaceutical company, bought a machine at a cost of $2 million five years ago that produces pain-reliever medicine. The machine has been
Taxes and depreciation: What is the difference between average tax rate and marginal tax rate? Which one should we use in calculating incremental after-tax cash flows?
Nominal versus real cash flows: What is the difference between nominal and real cash flows? Which rate of return should we use to discount each type of cash flow?
The FCF calculation: How do we adjust for depreciation when we calculate incremental after-tax free cash flow from EBITDA? What is the intuition for the adjustment?
The FCF calculation: How do we calculate incremental aftertax free cash flows from forecasted earnings of a project? What are the common adjustment items?
Calculating project cash flows: Why do we use forecasted incremental after-tax free cash flows instead of forecasted accounting earnings in estimating the NPV of a project?
Management of Skywards, Inc., an airline caterer, is purchasing refrigerated trucks at a total cost of $3.25 million. After-tax net income from this investment is expected to be $750,000 for each of
Quasar Tech Co. management is investing $6 million in new machinery that will produce the next-generation routers. Sales to its customers will amount to $1,750,000 for the next three years and then
Primus Corp. management is planning to convert an existing warehouse into a new plant that will increase its production capacity by 45 percent. The cost of this project will be $7,125,000. It will
Management of Dravid, Inc., is currently evaluating three independent projects. The cost of funds can be either 13.6 percent or
Refer to Problem 10.31.a. What are the IRRs for the projects?b. Does the IRR criterion suggest a different decision than the NPV criterion?c. Explain how you would expect the management of Draconian
Profitability index: Suppose that you could invest in the same projects as in the previous problem but have only $25,000 to invest.Which projects would you choose?
Internal rate of return: Compute the IRR for the following project cash flows:a. An initial outlay of $3,125,000 followed by annual cash flows of $565,325 for the next eight years.b. An initial
Internal rate of return: Compute the IRR on the following cash flow streams:a. An initial investment of $25,000 followed by a single cash flow of $37,450 in Year 6.b. An initial investment of $1
Internal rate of return: Refer to Problem 10.5. Compute the IRR for both Production System 1 and Production System 2. Which has the higher IRR? Which production system has the higher NPV?Explain why
Modified internal rate of return (MIRR): Management of Sycamore Home Furnishings is considering acquiring a new machine that can create customized window treatments. The equipment will cost $263,400
Modified internal rate of return (MIRR): Morningside Bakeries recently purchased equipment at a cost of $650,000. Management expects the equipment to generate cash flows of $275,000 in each of the
Payback: Creative Solutions, Inc., has just invested $4,615,300 in new equipment. The firm uses a payback period criterion of rejecting any project that takes more than four years to recover its
Net present value: Champlain Corp. management is investigating two computer systems. The Alpha 8300 costs $3,122,300 and will generate cost savings of $1,345,500 in each of the next five years.The
Profitability index: What is the profitability index, and why is it helpful in the capital rationing process?
Internal rate of return: Hathaway, Inc., a resort management company, is refurbishing one of its hotels at a cost of $7.8 million.Management expects that this will lead to additional cash flows
Internal rate of return: Refer to Problem 10.4. What is the IRR that Franklin Mints management can expect on this project?
Average accounting rate of return (ARR): Capitol Corp.management is expecting a project to generate after-tax income of$63,435 in each of the next three years. The average book value of the
Payback: Nakamichi Bancorp has made an investment in banking software at a cost of $1,875,000. If management expects productivity gains and cost savings to generate additional cash flows of$586,212,
Payback: Northern Specialties just purchased inventory-management computer software at a cost of $1,645,276. Cost savings from the investment over the next six years will produce the following cash
Payback: Quebec, Inc., is purchasing machinery at a cost of$3,768,966. The company’s management expects the machinery to produce cash flows of $979,225, $1,158,886, and $1,881,497 over the next
Payback: Refer to Problem 10.5. What are the payback periods for Production Systems 1 and 2? If the systems are mutually exclusive and the firm always chooses projects with the lowest payback period,
Net present value: Management of Franklin Mints, a confectioner, is considering purchasing a new jelly bean–making machine at a cost of $312,500. It projects that the cash flows from this
Net present value: Kingston, Inc., management is considering purchasing a new machine at a cost of $4,133,250. It expects this equipment to produce cash flows of $814,322, $863,275,
Net present value: Riggs Corp. management is planning to spend $650,000 on a new marketing campaign. It believes that this action will result in additional cash flows of $325,000 over the next three
Nonconstant growth: Tin-Tin Waste Management, Inc., is growing rapidly. Dividends are expected to grow at rates of 30 percent, 35 percent, 25 percent, and 18 percent over the next four years.
Nonconstant growth: Diaz Corp. is expected to grow rapidly at a rate of 35 percent for the next seven years. The company’s first dividend, to be paid three years from now, will be $5. After seven
Nonconstant growth: Staggert Corp. will pay dividends of $5.00,$6.25, $4.75, and $3.00 in the next four years. Thereafter, management expects the dividend growth rate to be constant at 6 percent. If
Nonconstant growth: Quansi, Inc., management expects to pay no dividends for the next six years. It has projected a growth rate of 25 percent for the next seven years. After seven years, the firm
Nonconstant growth: Revarop, Inc., is a fast-growth company that is expected to grow at a rate of 23 percent for the next four years.It is then expected to grow at a constant rate of 6 percent.
Nonconstant growth: Management of ProCor, a biotech firm, forecasted the following growth rates for the next three years:35 percent, 28 percent, and 22 percent. Management then expects the company to
Nonconstant growth: Tre-Bien, Inc., is a fast-growing technology company. Management projects rapid growth of 30 percent for the next two years, then a growth rate of 17 percent for the following two
Nonconstant growth: You own a company that competes with Old World DVD Company (in the previous problem). Instead of selling DVDs, however, your company sells music downloads online. Things are going
Constant growth: Jenny Banks is interested in buying the stock of Fervan, Inc., which is increasing its dividends at a constant rate of 6 percent. Last year the firm paid a dividend of $2.65. The
Preferred stock valuation: Each quarter, Sirkota, Inc., pays a dividend on its perpetual preferred stock. Today the stock is selling at$63.37. If the required rate of return for such stocks is 15.5
Preferred stock valuation: The First Bank of Flagstaff has issued perpetual preferred stock with a $100 par value. The bank pays a quarterly dividend of $1.65 on this stock. What is the current price
Preferred stock valuation: X-Centric Energy Company has issued perpetual preferred stock with a stated (par) value of $100 and a dividend of 4.5 percent. If the required rate of return is 8.25
Constant growth: Proxicam, Inc., is expected to grow at a constant rate of 7 percent. If the company’s next dividend, which will be paid in a year, is $1.15 and its current stock price is $22.35,
Constant growth: Reco Corp. is expected to pay a dividend of$2.25 next year. The forecast for the stock price a year from now is$37.50. If the required rate of return is 14 percent, what is the
Constant growth: Nyeil, Inc., is a consumer products firm that is growing at a constant rate of 6.5 percent. The firm’s last dividend, which was just paid, was $3.36. If the required rate of return
Constant growth: Moriband Corp. paid a dividend of $2.15 yesterday. The company’s dividend is expected to grow at a steady rate of 5 percent for the foreseeable future. If investors in stocks of
Zero growth: The current stock price of Largent, Inc., is $44.72.If the required rate of return is 19 percent, what is the dividend paid by this firm if the dividend is not expected to grow in the
Zero growth: Ron Santana is interested in buying the stock of First National Bank. While the bank’s management expects no growth in the near future, Ron is attracted by the dividend income.Last
Zero growth: Knight Supply Corp. has not grown for the past several years, and management expects this lack of growth to continue.The firm last paid a dividend of $3.56. If you require a rate of
Zero growth: Nynet, Inc., paid a dividend of $4.18 last year. The company’s management does not expect to increase its dividend in the foreseeable future. If the required rate of return is 18.5
Present value of dividends: Fresno Corp. is a fast-growing company whose management expects it to grow at a rate of 30 percent over the next two years and then to slow to a growth rate of 18 percent
Dividend yield: What is a dividend yield? What does it tell us?
Stock market index: What does NASDAQ stand for? What is NASDAQ?
Stock market index: What is the Dow Jones Industrial Average?
Stock market index: What is a stock market index?
Hastings Corporation has a discount bond making semiannual coupon payments at a rate of 5.2 percent, with 10 years to maturity.The current market rate for similar securities is 6.4 percent. Pivotal
Peabody Corp. has seven-year bonds outstanding. The bonds pay a coupon rate of 8.375 percent semiannually and are currently worth$1,063.49. The bonds can be called in three years at a price of
Showbiz, Inc., has issued eight-year bonds with a coupon rate of 6.375 percent and semiannual coupon payments. The market’s required rate of return on such bonds is 7.65 percent.a. What is the
Pullman Corp issued 10-year bonds four years ago with a coupon rate of 9.375 percent. At the time of issue, the bonds sold at par. Today bonds of similar risk and maturity must pay an annual coupon
Realized yield: You bought a six-year bond issued by Runaway Corp. four years ago. At that time, you paid $974.33 for the bond. The bond pays a coupon rate of 7.375 percent, and coupon payments are
Realized yield: Trevor Price bought 10-year bonds issued by Harvest Foods five years ago for $936.05. The bonds make semiannual coupon payments at a rate of 8.4 percent. If the current price of the
Realized yield: Brown & Co. issued seven-year bonds two years ago that can be called after two years. The bonds make semiannual coupon payments at a coupon rate of 7.875 percent. Each bond has a
Yield to maturity: Adrienne Dawson is planning to buy 10-year zero coupon bonds issued by the U.S. Treasury. If these bonds have a face value of $1,000 and are currently selling at $404.59, what is
Yield to maturity: Serengeti Corp. has five-year bonds outstanding that pay a coupon rate of 8.8 percent. If these bonds are priced at$1,064.86, what is the yield to maturity on these bonds? Assume
Yield to maturity: Electrolex, Inc., has four-year bonds outstanding that pay a coupon rate of 6.6 percent and make coupon payments semiannually. If these bonds are currently selling at $914.89, what
Zero coupon bonds: Rockinghouse Corp. management plans to issue seven-year zero coupon bonds. It has learned that these bonds will sell today at a price of $439.76. Assuming annual coupon payments,
Zero coupon bonds: Kintel, Inc., management wants to raise$1 million by issuing six-year zero coupon bonds with a face value of$1,000. The company’s investment banker states that investors would
Bond price: Nanotech, Inc., has a bond issue maturing in seven years that is paying a coupon rate of 9.5 percent (semiannual payments).Management wants to retire a portion of the issue by buying the
Bond price: Rockne, Inc., has outstanding bonds that will mature in six years and pay an 8 percent coupon semiannually.If you paid $1,036.65 today and your required rate of return was 6.6 percent,
Bond price: Marshall Company is issuing eight-year bonds with a coupon rate of 6.5 percent and semiannual coupon payments. If the current market rate for similar bonds is 8 percent, what will the
Bond price: Lopez Information Systems management is planning to issue 10-year bonds. The going market yield for such bonds is 8.125 percent. Assume that coupon payments will be made
Bond price: The International Publishing Group is raising$10 million by issuing 15-year bonds with a coupon rate of 8.5 percent.Coupon payments will be made annually. Investors buying the bonds today
Realized yield: Four years ago, Lisa Stills bought six-year, 5.5 percent coupon bonds issued by the Fairways Corp. for $947.68.If she sells these bonds at the current price of $894.52, what will be
Realized yield: Josh Kavern bought 10-year, 12 percent coupon bonds issued by the U.S. Treasury three years ago at $913.44.If he sells these bonds, for which he paid the face value of $1,000, at the
Yield to maturity: Rudy Sandberg wants to invest in four-year bonds that are currently priced at $868.43. These bonds have a coupon rate of 6 percent and make semiannual coupon payments. What is the
Yield to maturity: Ruth Hornsby is looking to invest in a threeyear bond that makes semiannual coupon payments at a rate of 5.875 percent. If these bonds have a market price of $981.13, what yield to
Zero coupon bonds: Northrop Real Estate Company management is planning to fund a development project by issuing 10-year zero coupon bonds with a face value of $1,000. Assuming semiannual compounding,
Zero coupon bonds: Diane Carter is interested in buying a fiveyear zero coupon bond with a face value of $1,000. She understands that the market interest rate for similar investments is 9 percent.
Bond price: You are interested in investing in a five-year bond that pays a 7.8 percent coupon rate with interest to be received semiannually.Your required rate of return is 8.4 percent. What is the
Bond price: Knight, Inc., has issued a three-year bond that pays a coupon rate of 6.10 percent. Coupon payments are made semiannually.Given the market rate of interest of 5.80 percent, what is the
Bond price: Pierre Dupont just received a cash gift from his grandfather. He plans to invest in a five-year bond issued by Venice Corp. that pays an annual coupon rate of 5.5 percent. If the current
Bond price: BA Corp is issuing a 10-year bond with a coupon rate of 8 percent. The interest rate for similar bonds is currently 6 percent.Assuming annual payments, what is the value of the bond?
An investor holds a 10-year bond paying a coupon rate of 9 percent. The yield to maturity of the bond is 7.8 percent. Would you expect the investor to be holding a par-value, premium, or discount
Explain why bond prices and interest rates are negatively related.What are the roles of the coupon rate and the term to maturity in this relation?
We know that a vanilla bond with a coupon rate below the market rate of interest will sell for a discount and that a vanilla bond with a coupon rate above the market rate of interest will sell for a
Tonalli is putting together a portfolio of 10 stocks in equal proportions.What is the relative importance of the variance for each stock versus the covariance for the pairs of stocks in her
In order to fund her retirement, Glenda needs her portfolio to have an expected return of 12 percent per year over the next 30 years.She has decided to invest in Stocks 1, 2, and 3, with 25 percent
Peter knows that the covariance of the return on two assets is−0.0025. Without knowing the expected return of the two assets, explain what that covariance means.

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