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fundamentals of corporate finance

Questions and Answers of Fundamentals Of Corporate Finance

25. Growth Opportunities. Trend-Line Inc. has been growing at a rate of 6% per year and is expected to continue to do so indefinitely. The next dividend is expected to be $5 per share. (LO2)a. If the
26. P/E Ratios. Castles in the Sand generates a rate of return of 20% on its investments and main- tains a plowback ratio of .30. Its earnings this year will be $4 per share. Investors expect a 12%
27. Dividend Growth. Grandiose Growth has a dividend growth rate of 20%. The discount rate is 10%. The end-of-year dividend will be $2 per share. (LO2)a. What is the present value of the dividend to
28. Stock Valuation. Start-Up Industries is a new firm that has raised $200 million by selling shares of stock. Management plans to earn a 24% rate of return on equity, which is more than the 15%
29. Nonconstant Growth. Planned Obsolescence has a product that will be in vogue for 3 years, at which point the firm will close up shop and liquidate the assets. As a result, forecast dividends are
30. Nonconstant Growth. Tattletale News Corp. has been growing at a rate of 20% per year, and you expect this growth rate in earnings and dividends to continue for another 3 years. (LO2)a. If the
31. Nonconstant Growth. Reconsider Tattletale News from the previous problem.a. What is your prediction for the stock price in 1 year? (LO2)b. Show that the expected rate of return equals the
32. Interpreting the Efficient-Market Theory. How would you respond to the following com- ments? (LOS)a. "Efficient market, my eye! I know lots of investors who do crazy things."b. "Efficient market?
33. Real versus Financial Investments. Why do investments in financial markets almost always have zero NPVs, whereas firms can find many investments in their product markets with posi- tive NPVs?
34. Investment Performance. It seems that every month we read an article in The Wall Street Journal about a stockpicker with a marvelous track record. Do these examples mean that finan- cial markets
35. Implications of Efficient Markets. The president of Good Fortunes, Inc., states at a press conference that the company has a 30-year history of ever-increasing dividend payments. Good Fortunes is
36. Implications of Efficient Markets. "Long-term interest rates are at record highs. Most com- panies, therefore, find it cheaper to finance with common stock or relatively inexpensive short- term
37. Expectations and Efficient Markets. Geothermal Corp. just announced good news: Its earn- ings have increased by 20%. Most investors had anticipated an increase of 25%. Will Geother- mal's stock
38. Behavioral Finance. In Section 7.7 we gave two examples of market anomalies (the earnings- announcement puzzle and the new-issue puzzle). Do you think that behavioral finance can help to explain
39. Sustainable Growth. Computer Corp. reinvests 60% of its earnings in the firm. The stock sells for $50, and the next dividend will be $2.50 per share. The discount rate is 15%. What is the rate of
40. Nonconstant Growth. A company will pay a $2 per share dividend in 1 year. The dividend in 2 years will be $4 per share, and it is expected that dividends will grow at 5% per year thereaf- ter.
41. Nonconstant Growth. Phoenix Industries has pulled off a miraculous recovery. Four years ago it was near bankruptcy. Today, it announced a $1 per share dividend to be paid a year from now, the
42. Nonconstant Growth. Compost Science, Inc. (CSI), is in the business of converting Boston's sewage sludge into fertilizer. The business is not in itself very profitable. However, to induce CSI to
43. Nonconstant Growth. Better Mousetraps has come out with an improved product, and the world is beating a path to its door. As a result, the firm projects growth of 20% per year for 4 years. By
44. Nonconstant Growth. (LO2)a. Return to the previous problem, and compute the value of Better Mousetraps for assumed sustainable growth rates of 6% through 9%, in increments of .5%.b. Compute the
45. Yield Curve and Efficient Markets. If the yield curve is downward-sloping, meaning that long-term interest rates are lower than short-term interest rates, what might investors believe about
1. Go to www.mhhe.com/edumarketinsight. Review Table 7-3, which lists the market values of several firms. Update the table. Which company's value changed by the greatest percentage since 2007, when
2. Using the constant dividend growth stock valuation model, estimate the current required rate of return, r, of H. J. Heinz (HNZ). Using the information from Market Insight's Company Profile and
3. From the Financial Highlights and Company Profile links of Market Insight, obtain the price- earnings ratios of Adobe Systems (ADBE) and American Electric Power (AEP). Which of these two firms
7.1 Expected industry profitability has fallen. Thus the value of future investment opportunities has fallen relative to the value of assets in place. This happens in all growth industries sooner or
7.2 DIV,+P $5+$105 7.2 Po= = $100 1+r 1.10
7.3 Since dividends and share price grow at 5%, DIV =$51.05 $5.25, DIV =$5x1.05 = $5.51 P=$1001.05 = $115.76 DIV DIV DIV+P Po + 1+r (1+r) (1+r) $5.00 $5.25 $5.51+$115.76 + = $100 1.10 (1.102) (1.10)
7.4 Po=3 $125 r .20
7.5 The two firms have equal risk, so we can use the data for Androscoggin to find the expected return on either stock: r= DIVI Po $5 +g +.05.10, or 10% $100
7.6 We've already calculated the present value of dividends through year 5 as $7.39. We can also forecast the dividend in year 6 as DIV = 1.055XDIV = 1.055x$2.34 $2.4687 Price in year 5 is $2.4687 Ps
7.7a. The sustainable growth rate is g=return on equity plowback ratio =10% X.40=4%b. First value the company. At a 60% payout ratio, DIV = $3 as before. Using the constant- growth model, Po= $3
7.8a. False. The levels of successive stock prices are related. If a stock is selling for $100 per share today, the best guess of its price tomorrow is $100.b. True. Changes in stock prices are
7.9 Fundamental analysts ensure that stock prices reflect all publicly available information about the underlying value of the firm. If share prices deviate from their fundamental values, such
1. Calculate the net present value of an investment.
2. Calculate the internal rate of return of a project and know what to look out for when using the internal rate of return rule.
3. Explain why the payback rule doesn't always make sharehold- ers better off.
4. Use the net present value rule to analyze three common prob- lems that involve competing projects: (a) when to postpone an investment expenditure, (b) how to choose between proj- ects with unequal
5. Calculate the profitability index and use it to choose between projects when funds are limited.
1. IRR/NPV. If the opportunity cost of capital is 11%, which of these projects is worth pursuing? (LOI)
2. Mutually Exclusive Investments. Suppose that you can choose only one of these projects. Which would you choose? The discount rate is still 11%. (LO5)
3. IRR/NPV. Which project would you choose if the opportunity cost of capital were 16%? (LOI)
4. IRR. What are the internal rates of return on projects A and B? (LO2)
5. Investment Criteria. In light of your answers to Quiz Questions 2-4, is there any reason to believe that the project with the higher IRR is the better project? (LO2)
6. Profitability Index. If the opportunity cost of capital is 11%, what is the profitability index for each project? Does the profitability index rank the projects correctly? (LO5)
7. Payback. What is the payback period of each project? (LO3)
8. Investment Criteria. Considering your answers to Quiz Questions 2, 3, and 7, is there any reason to believe that the project with the lower payback period is the better project? (LO3)
9. NPV and IRR. A project that costs $3,000 to install will provide annual cash flows of $800 for each of the next 6 years. Is this project worth pursuing if the discount rate is 10%? How high can
10. Payback. A project that costs $2,500 to install will provide annual cash flows of $600 for the next 6 years. The firm accepts projects with payback periods of less than 5 years. Will the project
11. Profitability Index. What is the profitability index of a project that costs $10,000 and pro- vides cash flows of $3,000 in years 1 and 2 and $5,000 in years 3 and 4? The discount rate is 9%.
12. NPV. A proposed nuclear power plant will cost $2.2 billion to build and then will produce cash flows of $300 million a year for 15 years. After that period (in year 15), it must be decommis-
13. NPV/IRR. Consider projects A and B:Calculate IRRs for A and B. Which project does the IRR rule suggest is best? Which project is really best? (LO2) Cash Flows (dollars) Project C C NPV at 10% A
14. IRR. You have the chance to participate in a project that produces the following cash flows:The internal rate of return is 13.6%. If the opportunity cost of capital is 12%, would you accept the
15. NPV/IRR.a. Calculate the net present value of the following project for discount rates of 0, 50, and 100%: (LOI)b. What is the IRR of the project? (LO2) Co C C2 -$6,750 +$4,500 +$18,000
16. IRR. Marielle Machinery Works forecasts the following cash flows on a project under consid- eration. It uses the internal rate of return rule to accept or reject projects. Should this project be
17. NPV/IRR. A new computer system will require an initial outlay of $20,000, but it will increase the firm's cash flows by $4,000 a year for each of the next 8 years. Is the system worth install-
18. Investment Criteria. If you insulate your office for $10,000, you will save $1,000 a year in heating expenses. These savings will last forever.a. What is the NPV of the investment when the cost
19. NPV versus IRR. Here are the cash flows for two mutually exclusive projects:a. At what interest rates would you prefer project A to B? (Hint: Try drawing the NPV profile of each project.).
20. Payback and NPV. A project has a life of 10 years and a payback period of 10 years. What must be true of project NPV? (L03)
21. IRR/NPV. Consider this project with an internal rate of return of 13.1%. Should you accept or reject the project if the discount rate is 12%? (LO2) Year Cash Flow 0 +$100 1 -60 2 -60
22. Payback and NPV.a. What is the payback period on each of the following projects? (LO3)b. Given that you wish to use the payback rule with a cutoff period of 2 years, which projects would you
23. Profitability Index. Consider the following projects: (LOS)a. Calculate the profitability index for A and B assuming a 22% opportunity cost of capital.b. Use the profitability index rule to
25. Profitability Index versus NPV. Consider these two projects: (LOS)a. Which project has the higher NPV if the discount rate is 10%?b. Which has the higher profitability index?c. Which project is
26. Mutually Exclusive Investments. Here are the cash flow forecasts for two mutually exclusive projects: (LOI)a. Which project would you choose if the opportunity cost of capital is 2%?b. Which
27. Equivalent Annual Annuity. A precision lathe costs $10,000 and will cost $20,000 a year to operate and maintain. If the discount rate is 10% and the lathe will last for 5 years, what is the
28. Equivalent Annual Annuity. A firm can lease a truck for 4 years at a cost of $30,000 annually. It can instead buy a truck at a cost of $80,000, with annual maintenance expenses of $10,000. The
29. Multiple IRR. Consider the following cash flows: (LO2)a. Confirm that one internal rate of return on this project is (a shade above) 7%, and that the other is (a shade below) 34%.b. Is the
30. Equivalent Annual Cost. Econo-Cool air conditioners cost $300 to purchase, result in electric- ity bills of $150 per year, and last for 5 years. Luxury Air models cost $500, result in electricity
31. Investment Timing. You can purchase an optical scanner today for $400. The scanner provides benefits worth $60 a year. The expected life of the scanner is 10 years. Scanners are expected to
32. Replacement Decision. You are operating an old machine that is expected to produce a cash inflow of $5,000 in each of the next 3 years before it fails. You can replace it now with a new machine
33. Replacement Decision. A forklift will last for only 2 more years. It costs $5,000 a year to maintain. For $20,000 you can buy a new lift that can last for 10 years and should require main-
36. Multiple IRRs. Strip Mining Inc. can develop a new mine at an initial cost of $5 million. The mine will provide a cash flow of $30 million in 1 year. The land then must be reclaimed at a cost of
37. Investment Criteria. A new furnace for your small factory will cost $27,000 a year to install and will require ongoing maintenance expenditures of $1,500 a year. But it is far more fuel-
8.1 Even if construction costs are $355,000, NPV is still positive: NPV PV - $355,000 - $357,143 - $355,000 = $2,143 Therefore, the project is still worth pursuing. The project is viable as long as
8.2 The payback period is $5,000/$660 = 7.6 years. Discounted payback is just over 11 years. Calculate NPV as follows. The present value of a $660 annuity for 20 years at 6% is PV annuity $7,570
8.3 The IRR is now about 8.9% because 8.4 $16,000 $16,000 $416,000 NPV -$350,000+ 0 1.089 (1.089) (1.089) Note in Figure 8-6 that NPV falls to zero as the discount rate reaches 8.9%.
8.4 You want to be rich. The NPV of the long-lived investment is much larger. Short: NPV -$1+1 = Long: NPV = -$1+- $2 1.075 $.3 .075 = + $.8605 million +$3 million
8.5 You want to be richer. The second alternative generates greater value at any reasonable dis- count rate. Other risk-free investments offer 7.5%. Therefore NPV -$1,000+ $4,000 1.075 +$2,721 NPV
8.6 Purchase the new computer now. Year of Purchase Cost of Computer NPV at Year PV Savings of Purchase NPV Today 0 $50 $70 $20 $20 1 45 66 21 19.1 2 40 62 22 18.2 3 36 58 22 16.5 45 33 54 21 14.3 31
8.7 Machine I is the better buy. However, it's still better to keep the old machine going for 1 more year. That costs $4,300, which is less than I's equivalent annual cost, $6,019. Year: 0 1 2 3 PV
8.8 Rank each project in order of profitability index as in the following table:Starting from the top, we run out of funds after accepting projects L and J. While J and M have equal profitability
8.9 The profitability index gives the correct ranking for the first pair, but the incorrect ranking for the second: Project Short PV $1,860,500 Investment NPV Profitability Index (NPV/Investment)
8.1 NPV would be calculated as 221.08 million.
8.2 This value, 221.08 million, is 1.13 times as great as the value in Table 8-1 because each cash flow is discounted for one fewer period. The Excel NPV function assumes the first cash flow comes
1. Identify the cash flows properly attributable to a proposed new project.
2. Calculate the cash flows of a project from standard financial statements.
3. Understand how the company's tax bill is affected by depre- ciation and how this affects project value.
4. Understand how changes in working capital affect project cash flows.
1. Cash Flows. A new project will generate sales of $74 million, costs of $42 million, and depre- ciation expense of $10 million in the coming year. The firm's tax rate is 35%. Calculate cash flow
2. Cash Flows. Canyon Tours showed the following components of working capital last year: (LO2)a. What was the change in net working capital during the year?b. If sales were $36,000 and costs were
6. Calculating Net Income. The owner of a bicycle repair shop forecasts revenues of $160,000 a year. Variable costs will be $50,000, and rental costs for the shop are $30,000 a year. Depre- ciation
7. Cash Flows. Calculate the operating cash flow for the repair shop in the previous problem using all three methods suggested in the chapter: (a) adjusted accounting profits; (b) cash inflow/cash
8. Cash Flows and Working Capital. A house painting business had revenues of $16,000 and expenses of $9,000. There were no depreciation expenses. However, the business reported the following changes
10. Operating Cash Flows. Laurel's Lawn Care, Ltd., has a new mower line that can generate rev- enues of $120,000 per year. Direct production costs are $40,000, and the fixed costs of main- taining
11. Operating Cash Flows. Talia's Tutus bought a new sewing machine for $40,000 that will be depreciated using the MACRS depreciation schedule for a 5-year recovery period. (LO2)a. Find the
12. Proper Cash Flows. Conference Services Inc. has leased a large office building for $4 million per year. The building is larger than the company needs; two of the building's eight stories are
13. Cash Flows and Working Capital. A firm had after-tax income last year of $1.2 million. Its depreciation expenses were $.4 million, and its total cash flow was $1.2 million. What hap- pened to net
14. Cash Flows and Working Capital. The only capital investment required for a small project is investment in inventory. Profits this year were $10,000, and inventory increased from $4,000 to $5,000.
15. Cash Flows and Working Capital. A firm's balance sheets for year-end 2008 and 2009 con- tain the following data. What happened to investment in net working capital during 2009? All items are in
16. Salvage Value. Quick Computing (from Quiz Question 5) installed its previous generation of computer chip manufacturing equipment 3 years ago. Some of that older equipment will become unnecessary
17. Salvage Value. Your firm purchased machinery with a 7-year MACRS life for $10 million. The project, however, will end after 5 years. If the equipment can be sold for $4.5 million at the

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