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fundamentals of corporate finance 10th

Questions and Answers of Fundamentals Of Corporate Finance 10th

Calculating Payback An investment project provides cash inflows of £765 per year for 8 years. What is the project payback period if the initial cost is £2,400? What if the initial cost is £3,600?
Calculating Payback Shire plc has the following mutually exclusive projects. Suppose Shire’s payback period cut-off is 2 years. Which of these two projects should be chosen?Year Cash flow(A)
Calculating Discounted Payback An investment project has annual cash inflows of £20,000, £35,400, £48,000 and£54,000 and a discount rate of 14 per cent. What is the discounted payback period for
Calculating Discounted Payback An investment project costs €30,000, and has annual cash flows of €8,300 for 6 years. What is the discounted payback period if the discount rate is zero per cent?
Calculating AAR Your firm is considering purchasing a machine which requires an annual investment of €16,000.Depreciation is calculated using 20 per cent reducing balance. The machine generates, on
Calculating IRR Marielle Machinery Works is considering a project which has the following cash flows.The company uses the IRR rule to accept or reject projects, and has asked for your assessment on
Calculating NPV For the cash flows in the previous problem, suppose the firm uses the NPV decision rule. At a required return of 12 per cent, should the firm accept this project? What if the required
Calculating NPV and IRR A project that provides annual cash flows of €28,500 for nine years costs€138,000 today. Is this a good project if the required return is 8 per cent? What if it’s 20 per
Calculating IRR What is the IRR of the following set of cash flows?Year Cash flow (£)0 –£19,500 1 9,800 2 10,300 3 8,600
Calculating NPV For the cash flows in the previous problem, what is the NPV at a discount rate of zero per cent? What if the discount rate is 5 per cent? If it is 15 per cent? If it is 25 per cent?
Project Evaluation 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
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
NPV versus IRR Consider the following two mutually exclusive projects:Year Cash flow(X) (DKr)Cash flow(Y) (DKr)0 –15,000–15,000 1 8,150 7,700 2 5,050 5,150 3 6,800 7,250 Sketch the NPV profiles
Suppose you are offered £5,000 today but must make the following payments Year Cash flow (£)0 5,000 1 2,500 2 2,000 3 1,000 4 1,000 (a) What is the IRR of this offer?(b) f the appropriate discount
Calculating Profitability Index What is the profitability index for the following set of cash flows? Should the project be accepted or rejected if the discount rate is 14 per cent?Year Cash flow
Calculating Profitability Index Suppose the following two independent investment opportunities are available to Greenplain Ltd. The appropriate discount rate is 10 per cent.Year Project Alpha
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
NPV and Discount Rates An investment has an installed cost of €700,000. The cash flows over the four-year life of the investment are projected to be €250,000, €300,000,€225,000 and
MIRR Slow Ride plc is evaluating a project with the following cash flows:Year Cash flow (£)0 –19,000 1 7,100 2 8,800 3 9,400 4 4,500 5 –7,100 The company uses a 12 per cent interest rate on all
MIRR Suppose the company in the previous problem uses an 11 per cent discount rate and an 8 per cent reinvestment rate on all of its projects. Calculate the MIRR of the project using all three
Payback and NPV An investment under consideration has a payback of seven years and a cost of €724,000. If the required return is 12 per cent, what is the worst-case NPV? The best-case NPV? Explain.
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 between
NPV Valuation 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
Problems with IRR A project has the following cash flows:Year Cash flow (£)0 58,000 1 –34,000 2 –45,000 What is the IRR for this project? If the required return is 12 per cent, should the firm
Problems with IRR Kilmaheedin ltd has a project with the following cash flows:Year Cash flow (£)0 20,000 1 –26,000 2 13,000 What is the IRR of the project? What is happening here?
NPV and IRR Gulliver International Limited is evaluating a project in Lilliput. The project will create the following cash flows:Year Cash flow (LP)0 –750,000 1 205,000 2 265,000 3 346,000 4
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.
Based on your analysis, should the company open the mine?
Bonus question: Most spreadsheets do not have a built-in formula to calculate the payback period. Write a VBA script that calculates the payback period for a project
Describe how to calculate the future value of a series of cash flows.
Describe how to calculate the present value of a series of cash flows.
Unless we are explicitly told otherwise, what do we always assume about the timing of cash flows in present and future value problems?
In general, what is the present value of an annuity of C per period at a discount rate of r per period? The future value?
In general, what is the present value of a perpetuity?
If an interest rate is given as 12 per cent compounded daily, what do we call this rate?
What is an APR? What is an EAR? Are they the same thing?
In general, what is the relationship between a stated interest rate and an effective interest rate? Which is more relevant for financial decisions?
What does continuous compounding mean?
What is a pure discount loan? An interest-only loan?
What does it mean to amortize a loan?
What is a balloon payment? How do you determine its value?
Present Values with Multiple Cash Flows A top footballer has been signed to a three-year, £10 million contract. The details provide for an immediate cash bonus of £2 million. The player is to
Future Value with Multiple Cash Flows You plan to make a series of deposits in an individual retirement account. You will deposit £1,000 today, £2,000 in two years, and £2,000 in five years. If
Annuity Present Value You are looking into an investment that will pay you €12,000 per year for the next 10 years. If you require a 15 per cent return, what is the most you would pay for this
It’s the Principal that Matters Suppose you borrow £10,000. You are going to repay the loan by making equal annual payments for five years. The interest rate on the loan is 14 per cent per
Just a Little Bit Each Month You’ve recently finished your MBA. Naturally, you must purchase a new BMW immediately. The car costs about £21,000. The bank quotes a nominal annual interest rate of
Present Value and Multiple Cash Flows Investment X offers to pay you £6,000 per year for nine years, whereas Investment Y offers to pay you £8,000 per year for 6 years. Which of these cash flow
Future Value and Multiple Cash Flows Herlige Narren AS has identified an investment project with the following cash flows. If the discount rate is 10 per cent, what is the future value of these cash
Present Value A 25-year fixed-rate mortgage has monthly payments of €717 per month and a mortgage interest rate of 6.14 per cent per year compounded monthly. If a buyer purchases a home with the
Calculating Annuity Values You want to have DKr450,000 in your savings account 10 years from now, and you’re prepared to make equal annual deposits into the account at the end of the year. If the
Calculating EAR Find the EAR in each of the cases below.Stated Rate (APR)Number of Times Compounded 4% Quarterly 8% Monthly 12% Daily 16% Infinite
Continuous Compounding A zero coupon bond that will pay €1,000 is selling today at €422.41. What is the continuously compounded annual interest rate on the bond?
Calculating Future Values If you invest €1,000 in a savings account that pays 4 per cent every year, how long would it take to triple your money?
Calculating Present Values An investment will pay you£58,000 in seven years. If the appropriate discount rate is 10 per cent compounded daily, what is the present value?
Calculating EAR Friendly’s Quick Loans offers you‘two for four or I knock on your door’. This means you get £2 today and repay £4 when you get your wages in 1 week (or else). What’s the
Calculating Annuity Future Values You are planning to make monthly deposits of £400 into a retirement account that pays 7 per cent interest compounded monthly. If your first deposit will be made 1
Calculating Annuity Present Values Beginning three months from now, you want to be able to withdraw €1,200 each quarter from your bank account to cover university expenses over the next four years.
Discounted Cash Flow Analysis If the appropriate discount rate for the following cash flows is 9 per cent per year, what is the present value of the cash flows? Assume cash flows are generated at the
Effective Annual Rate You have been charged with putting together a redundancy package for a departing executive. The executive has asked for the following:(1) The present value of the next two
Calculating Future Values You have an investment that will pay you 1.17 per cent per month. How much will you have per euro invested in 1 year? 2 years?
Calculating Rates of Return Suppose an investment offers to triple your money in 12 months (don’t believe it).Assume the rate is compounded quarterly. What rate of return per quarter are you being
Present Value and Interest Rates What is the relationship between the value of an annuity and the level of interest rates? Suppose you just bought a 20-year annuity of £19,000 per year at the
Calculating Present Values A 3-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 cent
Interest You work for a 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
Comparing Cash Flows You have your choice of two investment accounts. Investment A is a 20-year annuity that features end-of-month NKr12,000 payments and has an interest rate of 6 per cent compounded
Annuities A couple will retire in 50 years; they plan to spend about £30,000 a year in retirement, which should last about 25 years. They believe that they can earn 8 per cent interest on retirement
Discount Interest Rates This question illustrates what is known as discount interest. Imagine you are discussing a loan with a somewhat unscrupulous lender. You want to borrow £25,000 for one year.
EAR versus APR Two banks in the area offer 30-year,£240,000 mortgages at 6.8 per cent quoted rate and charge a £2,300 loan application fee. However, the application fee charged by Insecurity Bank
Future Value and Multiple Cash Flows An insurance company is offering a new policy to its customers.Typically, the policy is bought by a parent or grandparent for a child at the child’s birth. The
Calculating Interest Rates A financial planning service offers a university savings programme. The plan calls for you to make six annual payments of £9,000 each, with the first payment occurring
Calculating EAR A pawnbroker store is in the business of making personal loans to walk-up customers. The store makes only one-week loans at 7 per cent interest per week.(a) What APR must the store
Rule of 72 Earlier, we discussed the Rule of 72, a useful approximation for many interest rates and periods for the time it takes a lump sum to double in value. For a 10 per cent interest rate, show
What other, perhaps non-quantifiable, factors affect Ben’s decision to get an MBA?
Ben believes that the appropriate analysis is to calculate the future value of each option. How would you evaluate this statement?
What initial salary would Ben need to receive to make him indifferent between attending Wilton University and staying in his current position?
Suppose, instead of being able to pay cash for his MBA, Ben must borrow the money. The current borrowing rate is per cent. How would this affect his decision?
What is meant by overconfidence and over-optimism? How are they likely to be costly?
Explain how self-attribution bias is similar but subtly different from confirmation bias.
What are the most effective ways for companies to overcome the planning fallacy?
What is frame dependence? How is it likely to be costly?
What is loss aversion? How is it likely to be costly?
What is the house money effect? Why is it irrational?
What is the affect heuristic? How is it likely to be costly?
What is the representativeness heuristic? How is it likely to be costly?
In 2015, the share price of Volkswagen fell dramatically when the US Environmental Protection Agency announced that many of their cars had ‘defeat devices’ that led to a mis-measurement of carbon
Behavioural Finance and Efficient Markets Proponents of behavioural finance use three concepts to argue that markets are not efficient. What are these arguments?
Frame Dependence In the chapter we presented an example where you had lost €78 and were given the opportunity to make a wager in which your loss would increase to €100 for 80 per cent of the time
Efficient Market Theory versus Behavioural Finance Compare and contrast both theories. In your opinion, which is the most reflective of market behaviour? Explain.
Technical Analysis What would a technical analyst say about market efficiency? What would a technical analyst say about behavioural finance?
Corporate Insider Trading Across the world, corporate insiders appear to consistently earn positive abnormal returns when they buy the equity of their own company.Although it could be argued that
Behavioural Finance versus Market Efficiency Some people argue that the efficient market hypothesis cannot explain the 2010 US flash market crash or the high priceto-earnings ratio of European shares
Shareholder Activism Many financial institutions use the media to drive shareholder activism strategies so that pressure is maximized on the target firm managers. Is this evidence that institutional
Investor Sentiment Some people believe that following the European Commission’s Economic Sentiment Indicator (see chart below) allows you to predict future market movements. What is the Economic
Use a method learned in this chapter as the basis of a communications strategy to investors. Explain what your strategy is, the behavioural concept it is founded on, and the expected outcome of the
Assume that you are an activist investor wishing to purchase the firm at a cheap price. What behavioural strategy would you use to pressurize the management into giving you a seat on the board of
If the market is efficient, how effective would the strategies in questions 1 and 2 be? Explain your reasoning.
What is the primary determinant of the cost of capital for an investment?
What is the relationship between the required return on an investment and the cost of capital associated with that investment?
What do we mean when we say that a corporation’s cost of equity capital is 16 per cent?
What are two approaches to estimating the cost of equity capital?

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