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fundamentals of corporate finance

Questions and Answers of Fundamentals Of Corporate Finance

9. Unique versus Market Risk. Figure 12-10 shows plots of monthly rates of return on three stocks versus the stock market index. The beta and standard deviation of each stock is given beside its
10. Calculating Beta. Following are several months' rates of return for Tumblehome Canoe Com- pany. Prepare a plot like Figure 12-1. What is Tumblehome's beta? (LOI) Month Market Return, % Tumblehome
11. Expected Returns. Consider the following two scenarios for the economy and the returns in each scenario for the market portfolio, an aggressive stock A, and a defensive stock D. (LO2)a. Find the
12. CAPM and Cost of Capital. Draw the security market line when the Treasury bill rate is 4% and the market risk premium is 7%. What are the project costs of capital for new ventures with betas of
13. CAPM and Valuation. You are a consultant to a firm evaluating an expansion of its current business. The cash-flow forecasts (in millions of dollars) for the project are as follows: (LO3)On the
14. CAPM and Cost of Capital. Reconsider the project in the preceding problem. What is the project IRR? What is the cost of capital for the project? Does the accept-reject decision using IRR agree
15. CAPM and Valuation. A share of stock with a beta of .75 now sells for $50. Investors expect the stock to pay a year-end dividend of $2. The T-bill rate is 4%, and the market risk premium is 7%.
16. CAPM and Expected Return. Reconsider the stock in the preceding problem. Suppose inves- tors actually believe the stock will sell for $52 at year-end. Is the stock a good or bad buy? What will
17. Portfolio Risk and Return. Suppose that the S&P 500, with a beta of 1.0, has an expected return of 13% and T-bills provide a risk-free return of 5%. (LO2)a. What would be the expected return and
18. Portfolio Risk and Return. Suppose that the S&P 500, with a beta of 1.0, has an expected return of 10% and T-bills provide a risk-free return of 4%. (LOI)a. How would you construct a portfolio
19. CAPM and Valuation. You are considering the purchase of real estate that will provide per- petual income that should average $50,000 per year. How much will you pay for the property if you
20. Risk and Return. According to the CAPM, would the expected rate of return on a security with a beta less than zero be more or less than the risk-free interest rate? Why would investors be willing
21. CAPM and Expected Return. The following table shows betas for several companies. Calculate each stock's expected rate of return using the CAPM. Assume the risk-free rate of interest is 5%. Use a
22. CAPM and Expected Return. Stock A has a beta of .5, and investors expect it to return 5%. Stock B has a beta of 1.5, and investors expect it to return 13%. Use the CAPM to find the mar- ket risk
23. CAPM and Expected Return. If the expected rate of return on the market portfolio is 13% and T-bills yield 6%, what must be the beta of a stock that investors expect to return 10%? (LO2)
24. Project Cost of Capital. Suppose Cisco is considering a new investment in the common stock of a pharmaceutical company. Which of the betas shown in the table in problem 21 is most relevant in
26. CAPM and Expected Return. A mutual fund manager expects her portfolio to earn a rate of return of 11% this year. The beta of her portfolio is .8. If the rate of return available on risk-free
28. Required Rate of Return. In view of your answer to the preceding problem, explain why a mutual fund must be able to provide an expected rate of return in excess of that predicted by the security
29. CAPM. We Do Bankruptcies is a law firm that specializes in providing advice to firms in finan- cial distress. It prospers in recessions when other firms are struggling. Consequently, its beta is
30. Leverage and Portfolio Risk. Footnote 4 in the chapter asks you to consider a borrow-and- invest strategy in which you use $1 million of your own money and borrow another $1 million to invest $2
31. Beta. Go to our Online Learning Center at www.mhhe.com/bmm6e, and link to the material for Chapter 12, where you will find a spreadsheet containing 5 years of monthly rates of return on Dell
1. Use data from Market Insight (www.mhhe.com/edumarketinsight) to calculate the beta of General Motors (GM). Start by obtaining the monthly rates of return of GM and the S&P 500 over the most recent
2. Go to Market Insight at www.mhhe.com/edumarketinsight. Enter the ticker symbol "GOOG" for Google. In the Excel Analytics section, click on Monthly Valuation Data. Save the monthly returns for
12.1 See Figure 12-11. Anchovy Queen's beta is 1.0.
12.2 A portfolio's beta is just a weighted average of the betas of the securities in the portfolio. In this case the weights are equal, since an equal amount is assumed invested in each of the stocks
12.3 The standard deviation of a fully diversified portfolio's return is proportional to its beta. The standard deviation in this case is .5 x 20 = 10%.
12.4 r=r,+B(rm-r) = 6+ (1.5 x 7) = 16.5%
12.5 Put 25% of your money in the market portfolio and the rest in Treasury bills. The portfolio's beta is .25 and its expected return is portfolio =(.756)+(.2513)=7.75% The expected return also may
12.6 portfolio (.4 x 6)+(.6 X 13) = 10.2%. This portfolio's beta is .6, since $600,000, which is 60% of the investment, is in the market portfolio. Investors in a stock with a beta of .6 would not
12.7 Present value = $50 million X 10-year annuity factor at 11.9% = $283.7 million.
12.8 Dell should use Pfizer's cost of capital, 7.7%. Dell's company cost of capital tells us what expected rate of return investors demand from the computer hardware business. This is not the
12.1 We would expect beta to fall from the value obtained in the spreadsheet. Ford's return in November (when the market fell) is not as bad as originally assumed, and its return in September (when
12.2 Ford's beta is precisely the same as the original value. Increasing the assumed return in each month by a constant does not change the typical responsiveness of Ford to variation in the return
12.3 If in the additional month of data Ford is down 5% while the market is up 5%, we would expect beta to fall. In this month, Ford's stock moved in opposition to the market index. Add- ing this
1. Calculate a firm's capital structure.
2. Estimate the required rates of return on the securities issued by the firm.
3. Calculate the weighted-average cost of capital.
4. Understand when the weighted-average cost of capital is-or isn't-the appropriate discount rate for a new project.
5. Use the weighted-average cost of capital to value a business given forecasts of its future cash flows.
1. Cost of Debt. Micro Spinoffs, Inc., issued 20-year debt a year ago at par value with a coupon rate of 8%, paid annually. Today, the debt is selling at $1,050. If the firm's tax bracket is 35%,
2. Cost of Preferred Stock. Micro Spinoffs also has preferred stock outstanding. The stock pays a dividend of $4 per share, and the stock sells for $40. What is the cost of preferred stock? (LO2)
3. Calculating WACC. Suppose Micro Spinoffs's cost of equity is 12%. What is its WACC if equity is 50%, preferred stock is 20%, and debt is 30% of total capital? (LO3)
4. Cost of Equity. Reliable Electric is a regulated public utility, and it is expected to provide steady growth of dividends of 5% per year for the indefinite future. Its last dividend was $5 per
5. Calculating WACC. Reactive Industries has the following capital structure. Its corporate tax rate is 35%. What is its WACC? (LO3) Security Debt Preferred stock Common stock Market Value $20
6. Company versus Project Discount Rates. Geothermal's WACC is 11.4%. Executive Fruit's WACC is 12.3%. Now Executive Fruit is considering an investment in geothermal power pro- duction. Should it
7. Company Valuation. Icarus Airlines is proposing to go public, and you have been given the task of estimating the value of its equity. Management plans to maintain debt at 30% of the company's
8. WACC. The common stock of Buildwell Conservation & Construction, Inc., has a beta of .90. The Treasury bill rate is 4%, and the market risk premium is estimated at 8%. BCCI's capital structure is
9. WACC and NPV. BCCI (see the previous problem) is evaluating a project with an internal rate of return of 12%. Should it accept the project? If the project will generate a cash flow of $100,000 a
10. Company Valuation. You need to estimate the value of Buildwell Conservation (see Practice Problem 8). You have the following forecasts (in millions of dollars) of Buildwell's profits and of its
11. Calculating WACC. Find the WACC of William Tell Computers. The total book value of the firm's equity is $10 million; book value per share is $20. The stock sells for a price of $30 per share, and
12. WACC. Nodebt, Inc., is a firm with all-equity financing. Its equity beta is .80. The Treasury bill rate is 4%, and the market risk premium is expected to be 10%. What is Nodebt's asset beta? What
13. Cost of Debt. A financial analyst at Dawn Chemical notes that the firm's total interest payments this year were $10 million while total debt outstanding was $80 million, and he concludes that the
14. Cost of Equity. Bunkhouse Electronics is a recently incorporated firm that makes electronic entertainment systems. Its earnings and dividends have been growing at a rate of 30%, and the current
15. Cost of Debt. Olympic Sports has two issues of debt outstanding. One is a 9% coupon bond with a face value of $20 million, a maturity of 10 years, and a yield to maturity of 10%. The coupons are
16. Capital Structure. Examine the following book-value balance sheet for University Products, Inc. What is the capital structure of the firm on the basis of market values? The preferred stock
17. Calculating WACC. Turn back to University Products's balance sheet from the previous prob- lem. If the preferred stock pays a dividend of $2 per share, the beta of the common stock is .8, the
18. Project Discount Rate. University Products is evaluating a new venture into home computer systems (see Practice Problems 16 and 17). The internal rate of return on the new venture is estimated at
19. Cost of Capital. The total market value of Okefenokee Real Estate Company is $6 million, and the total value of its debt is $4 million. The treasurer estimates that the beta of the stock cur-
20. Changes in Capital Structure. Look again at our calculation of Big Oil's WACC. Suppose Big Oil is excused from paying taxes. How would its WACC change? Now suppose Big Oil makes a large stock
21. Changes in Capital Structure. Refer again to Challenge Problem 20. Suppose Big Oil starts from the financing mix in Table 13-3, and then borrows an additional $200 million from the bank. It then
22. WACC and Taxes. "The after-tax cost of debt is lower when the firm's tax rate is higher; therefore, the WACC falls when the tax rate rises. Thus, with a lower discount rate, the firm must be
1. Find Caterpillar's S&P credit rating in Market Insight, and then find the current yields on simi- larly rated bonds at www.bondsonline.com. Find the after-tax cost of debt assuming a tax rate of
2. Use one of these estimates for the cost of equity:a. The constant-dividend-growth valuation model, given the current price, current dividend, and the 5-year dividend growth rate.b. The CAPM, using
3. Now find the weights for WACC. Use the book value (from the balance sheet) of long-term debt as an estimate of the market value of debt. Then find total market capitalization (total mar- ket value
4. Refer to Sections 13.4 and 13.5 of this chapter to calculate the WACC.
13.1 Hot Rocks' 4 million common shares are worth $40 million. Its market value balance sheet is:WACC=(.569%)+(.4417%)=12.5% We use Hot Rocks' pretax return on debt because the company pays no taxes.
13.2 Burg's 6 million shares are now worth only 6 million X $4 = $24 million. The debt is selling for 80% of book, or $20 million. The market value balance sheet is:WACC=(.4514%)+(.55x20% )=17.3%
13.3 Compare the two income statements, one for Criss-Cross Industries and the other for a firm with identical EBIT but no debt in its capital structure. (All figures in millions.)Notice that
13.4 For Hot Rocks, WACC=[.569(1-.35)]+(.4417)=10.8% For Burg Associates, WACC=[.45x14x(1-.35)]+(.55x20)=15.1%
13.5 WACC measures the expected rate of return demanded by debt and equity investors in the firm (plus a tax adjustment capturing the tax-deductibility of interest payments). Thus the calculation
13.6 From the CAPM: Tequity +equity (m-r) =6% +1.20(7.6%)=15.1% WACC=.3(1-.35) 8%+.7 (15.1%)=12.13%
13.7 Jo Ann's boss is wrong. The ability to borrow at 8% does not mean that the cost of capital is 8%. The firm could not finance a stand-alone project with 8% debt. This analysis ignores the side
13.8 Estimated horizon value for the concatenator business is 9 year-5 EBITDA = 9 239 = $2,151 thousand. PV (horizon value) is $2,151/(1.085) = $1,430.5 thousand. Adding in the PV of free cash flows
1. Explain why managers should assume that the securities they issue are fairly priced.
2. Interpret shareholder equity accounts in the firm's financial statements.
3. Describe voting procedures for the election of a firm's board of directors and other matters.
4. Describe the major classes of securities sold by the firm. 5. Summarize the changing ways that U.S. firms have financed their growth.
2. Equity Accounts. (LO2)a. Look back at Quiz Question 1. Suppose that the company issues 10,000 shares at $4 a share. Which of the above figures would change?b. What would happen to the company's
3. Financing Terms. Fill in the blanks by choosing the appropriate term from the following list: lease, funded, floating-rate, eurobond, convertible, subordinated, call, sinking fund, prime rate,
4. Financing Trends. True or false? Explain. (LO5)a. In several recent years, nonfinancial corporations in the United States have repurchased more stock than they have issued.b. A corporation pays
5. Preferred Stock. In what ways is preferred stock like long-term debt? In what ways is it like common stock? (LO4)\
6. Voting for Directors. If there are 10 directors to be elected and a shareholder owns 100 shares, indicate the maximum number of votes that he or she can cast for a favorite candidate undera.
7. Voting for Directors. The shareholders of the Pickwick Paper Company need to elect five directors. There are 400,000 shares outstanding. How many shares do you need to own to ensure that you can
8. Equity Accounts. Look back at Table 14-2. (LO2)a. Suppose that Heinz issues 10 million shares at $40 a share. Rework Table 14-2 to show the company's equity after the issue.b. Suppose that Heinz
9. Equity Accounts. Common Products has just made its first issue of stock. It raised $2 million by selling 200,000 shares of stock to the public. These are the only shares outstanding. The par value
10. Protective Covenants. Why might a bond agreement limit the amount of assets that the firm can lease? (LO4)
11. Bond Yields. Other things equal, will the following provisions increase or decrease the yield to maturity at which a firm can issue a bond? (LO4)a. A call provision.b. A restriction on further
12. Income Bonds. Income bonds are unusual. Interest payments on such bonds may be skipped or deferred if the firm's income is insufficient to make the payment. In what way are these bonds like
13. Preferred Stock. Preferred stock of financially strong firms sometimes sells at lower yields than the bonds of those firms. For weaker firms, the preferred stock has a higher yield. What might
1. Go to Market Insight at www.mhhe.com/edumarketinsight. Anheuser-Busch Inc. (BUD) used internal and external sources to fund its recent growth. Examine Anheuser-Busch's internal and external
2. What has happened to the book debt ratios (Ratios Report) of Anheuser-Busch Inc. (BUD) in the last few years? How has the debt ratio changed if one calculates debt ratios using the market value of
3. Compare the major sources and uses of funds (Annual Cash Flow Report and Balance Sheet) for General Mills (GIS) and Heinz (HNZ). What factors might explain the differences in financ- ing patterns
14.1 Par value of common shares must be $1 x 100,000 shares = $100,000. Additional paid-in capital is ($15 - $1) x 100,000 $1,400,000. Since book value is $4,500,000, retained earn- ings must be
14.2 The corporation's after-tax yield on the bonds is 10% - (.35 x 10%) = 6.5%. The after-tax yield on the preferred is 8% -1.35 x (.30 x 8%)] = 7.16%. The preferred stock provides the higher
14.3 Because the coupon on floating-rate debt adjusts periodically to current market conditions, the bondholder is less vulnerable to changes in market yields. The coupon rate paid by the bond is not
14.4 The callable bond will sell at a lower price. Investors will not pay as much for the callable bond since they know that the firm may call it away from them if interest rates fall. Thus they know
14.5 The extra debt makes it more likely that the firm will not be able to make good on its prom- ised payments to its creditors. If the new debt is not junior to the already-issued debt, then the
14.6 Capital markets provide liquidity for investors. Because individual stockholders can always lay their hands on cash by selling shares, they are prepared to invest in companies that retain
1. Distinguish among a bond's coupon rate, current yield, and yield to maturity.
2. Find the market price of a bond given its yield to maturity, find a bond's yield given its price, and demonstrate why prices and yields vary inversely.

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