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business
fundamentals of corporate finance

Questions and Answers of Fundamentals Of Corporate Finance

8. Du Pont Analysis. Use the data for Phone Corp. from Quiz Question I to do the following: (LO4)a. Calculate the ROE for Phone Corp.b. Demonstrate that ROE margin X debt burden. leverage ratio X
9. Asset Turnover. In each case, choose the firm that you expect to have a higher asset turnover ratio. (LO3)a. Economics Consulting Group or Pepsi.b. Catalog Shopping Network or Neiman Marcus.c.
10. Economic Value Added. We stated in Footnote 5 that EVA will be positive whenever ROE is greater than the cost of equity. Explain why this is so. (LO2)
11. Defining Ratios. There are no universally accepted definitions of financial ratios, but some of the following ratios make no sense at all. Substitute correct definitions. (LO3)a. Debt-equity
13. Current Ratio. How would the following actions affect a firm's current ratio? (LO3)a. Inventory is sold at cost.b. The firm takes out a bank loan to pay its accounts due.c. A customer pays its
14. Liquidity Ratios. A firm uses $1 million in cash to purchase inventories. What will happen to its current ratio? Its quick ratio? (LO3)
15. Receivables. Chik's Chickens has average accounts receivable of $6,333. Sales for the year were $9,800. What is its average collection period? (LO3)
16. Inventory. Salad Daze maintains an inventory of produce worth $400. Its total bill for produce over the course of the year was $73,000. How old on average is the lettuce it serves its custom-
17. Inventory Turnover. If a firm's inventory level of $10,000 represents 30 days' sales, what is the annual cost of goods sold? What is the inventory turnover ratio? (LO3)
18. Leverage Ratios. Lever Age pays an 8% rate of interest on $10 million of outstanding debt with face value $10 million. The firm's EBIT was $1 million. (LO3)a. What is times interest earned?b. If
19. Du Pont Analysis. Keller Cosmetics maintains an operating profit margin of 5% and asset turnover ratio of 3. (L04)a. What is its ROA?b. If its debt-equity ratio is 1, its interest payments and
20. Du Pont Analysis. Torrid Romance Publishers has total receivables of $3,000, which repre- sents 20 days' sales. Average total assets are $75,000. The firm's operating profit margin is 5%. Find
21. Leverage. A firm has a long-term debt-equity ratio of .4. Shareholders' equity is $1 million. Current assets are $200,000, and the current ratio is 2. The only current liabilities are notes pay-
22. Leverage Ratios. A firm has a debt-to-equity ratio of .5 and a market-to-book ratio of 2. What is the ratio of the book value of debt to the market value of equity? (LO3)
23. Times Interest Earned. In the past year, TVG had revenues of $3 million, cost of goods sold of $2.5 million, and depreciation expense of $200,000. The firm has a single issue of debt outstanding
24. Du Pont Analysis. CFA Corp. has a debt-equity ratio that is lower than the industry average, but its cash coverage ratio is also lower than the industry average. What might explain this seeming
25. Leverage. Suppose that a firm has both floating-rate and fixed-rate debt outstanding. What effect will a decline in market interest rates have on the firm's times interest earned ratio? On the
26. Interpreting Ratios. In each of the following cases, explain briefly which of the two compa- nies is likely to be characterized by the higher ratio: (LO3)a. Debt-equity ratio: a shipping company
27. Using Financial Ratios. For each category of financial ratios discussed in this chapter, give some examples of who would be likely to examine these ratios and why. (LO6)
28. Financial Statements. As you can see, someone has spilled ink over some of the entries in the balance sheet and income statement of Transylvania Railroad. Can you use the following infor- mation
29. Interpreting Financial Ratios. (LO3)a. Turn back to Table 4-8. For the sample of industries in that table, plot operating profit margin again asset turnover in a scatter diagram. What is the
1. Lowes (LOW) and The Home Depot (HD) have been in a tremendous race for the homeowner's dollar in the last few years. Who is winning? Review the company profiles (also review the industry
2. Compare the sources of return on equity (using the Du Pont formula) for Abercrombie & Fitch (ANF) and Gap, Inc. (GPS). Examine both levels and trends in these variables. Review the trends in
4.1 Market capitalization is $75 x 14.5 million = $1,087.5 million. Market value added is $1,087.5 $610 = $477.5 million. Market to book is 1,087.5/610 = 1.78. You can also cal- culate book value per
4.2 The cost of equity in dollars is .115 x $188 million = $21.62 million. EVA is $30 - $21.62 $8.38 million.
4.3 ROE measures return to equity as net income divided by the book value of equity. ROC and ROA measure the return to all investors, including interest paid as well as net income to share- holders.
4.5 In industries with rapid asset turnover, competition forces prices down, reducing profit margins.
4.6 Nothing will happen to the long-term debt ratio computed using book values, since the face values of the old and new debt are equal. However, times interest earned and cash coverage will
increase since the firm will reduce its interest expense.
4.7a. The firm must compensate for its below-average profit margin with an above-average turnover ratio. Remember that ROA is the product of operating margin X turnover.b. If ROA equals the industry
4..8a. The current ratio starts at 1.2/1.0 = 1.2. The transaction will reduce current assets to $.7 million and current liabilities to $.5 million. The current ratio increases to .7/.5 = 1.4. Net
4.9 The major portion of retail sales is paid for when the customer purchases the goods. Because credit sales are comparatively uncommon, accounts receivable are a smaller percentage of sales than
1. Calculate the future value to which money invested at a given interest rate will grow.
2. Calculate the present value of a future payment.
3. Calculate present and future values of a series of cash payments.
4. Find the interest rate implied by present and future values.
5. Compare interest rates quoted over different time intervals- for example, monthly versus annual rates.
6. Understand the difference between real and nominal cash flows and between real and nominal interest rates.
1. Present Values. Compute the present value of a $100 cash flow for the following combinations of discount rates and times: (LO2)a. r = 8%, t = 10 years.b. r = 8%, t = 20 years.c. r = 4%, t = 10
2. Future Values. Compute the future value of a $100 cash flow for the same combinations of rates and times as in Quiz Question 1. (LOI)
3. Future Values. In 1880 five aboriginal trackers were each promised the equivalent of 100 Australian dollars for helping to capture the notorious outlaw Ned Kelley. In 1993 the grand- daughters of
4. Future Values. You deposit $1,000 in your bank account. If the bank pays 4% simple interest, how much will you accumulate in your account after 10 years? What if the bank pays com- pound interest?
5. Present Values. You will require $700 in 5 years. If you earn 5% interest on your funds, how much will you need to invest today in order to reach your savings goal? (LO2)
6. Calculating Interest Rate. Find the interest rate implied by the following combinations of present and future values: (LO4) Present Value Years Future Value $400 11 $684 183 4 249 300 7 300
7. Present Values. Would you rather receive $1,000 a year for 10 years or $800 a year for 15 years ifa. the interest rate is 5%? (LO3)b. the interest rate is 20%? (LO3) Why do your answers to (a) and
8. Calculating Interest Rate. Find the annual interest rate. (LO4) Present Value Future Value Time Period $100 $115.76 3 years 200 262.16 4 100 110.41 5
9. Present Values. What is the present value of the following cash-flow stream if the interest rate is 6%? (LO3) Year Cash Flow 1 $200 2 400 3 300
10. Number of Periods. How long will it take for $400 to grow to $1,000 at the interest rate specified? (LOI)a. 4%b. 8%c. 16%
11. Calculating Interest Rate. Find the effective annual interest rate for each case. (LOS) APR 12% Compounding Period 1 month 8 3 10 10 6
12. Calculating Interest Rate. Find the APR (the stated interest rate) for each case. (LO5) Effective Annual Interest Rate 10.00% Compounding Period 1 month 6 6.09 8.24 3
13. Growth of Funds. If you earn 6% per year on your bank account, how long will it take an account with $100 to double to $200? (LOI)
14. Comparing Interest Rates. Suppose you can borrow money at 8.6% per year (APR) com- pounded semiannually or 8.4% per year (APR) compounded monthly. Which is the better deal? (L05)
15. Calculating Interest Rate. Lenny Loanshark charges "I point" per week (that is, 1% per week) on his loans. What APR must he report to consumers? Assume exactly 52 weeks in a year. What is the
16. Compound Interest. Investments in the stock market have increased at an average compound rate of about 5% since 1900. It is now 2007.a. If you invested $1,000 in the stock market in 1900, how
17. Compound Interest. Old Time Savings Bank pays 4% interest on its savings accounts. If you deposit $1,000 in the bank and leave it there, how much interest will you earn in the first year? The
18. Compound Interest. New Savings Bank pays 4% interest on its deposits. If you deposit $1,000 in the bank and leave it there, will it take more or less than 25 years for your money to double? You
19. Calculating Interest Rate. A zero-coupon bond that will pay $1,000 in 10 years is selling today for $422.41. What interest rate does the bond offer? (LO4)
20. Present Values. A famous quarterback just signed a $15 million contract providing $3 million a year for 5 years. A less famous receiver signed a $14 million 5-year contract providing $4 mil- lion
21. Compound Growth. In September 2007 a pound of apples cost $1.18, while oranges cost $1.50. Ten years earlier the price of apples was only $.93 a pound and that of oranges was $.96 a pound. What
22. Loan Payments. If you take out an $8,000 car loan that calls for 48 monthly payments at an APR of 10%, what is your monthly payment? What is the effective annual interest rate on the loan? (LO5)
23. Annuity Values. (LO3)a. What is the present value of a 3-year annuity of $100 if the discount rate is 6%?b. What is the present value of the annuity in (a) if you have to wait 2 years instead of
24. Annuities and Interest Rates. Professor's Annuity Corp. offers a lifetime annuity to retiring professors. For a payment of $80,000 at age 65, the firm will pay the retiring professor $600 a month
25. Annuity Values. You want to buy a new car, but you can make an initial payment of only $2,000 and can afford monthly payments of at most $400. (LO3)a. If the APR on auto loans is 12% and you
26. Calculating Interest Rate. In a discount interest loan, you pay the interest payment up front. For example, if a 1-year loan is stated as $10,000 and the interest rate is 10%, the borrower "pays"
28. Rate on a Loan. If you take out an $8,000 car loan that calls for 48 monthly payments of $240 each, what is the APR of the loan? What is the effective annual interest rate on the loan? (LO5)
30. Annuity Value. Your landscaping company can lease a truck for $8,000 a year (paid at year- end) for 6 years. It can instead buy the truck for $40,000. The truck will be valueless after 6 years.
31. Annuity-Due Value. Reconsider the previous problem. What if the lease payments are an annuity due, so that the first payment comes immediately? Is it cheaper to buy or lease? (LO3)
32. Annuity Due. A store offers two payment plans. Under the installment plan, you pay 25% down and 25% of the purchase price in each of the next 3 years. If you pay the entire bill imme- diately,
33. Annuity Value. Reconsider the previous question. How will your answer change if the pay- ments on the 4-year installment plan do not start for a full year? (LO3)
34. Annuity and Annuity-Due Payments. (LO3)a. If you borrow $1,000 and agree to repay the loan in five equal annual payments at an interest rate of 12%, what will your payment be?b. What if you make
35. Valuing Delayed Annuities. Suppose that you will receive annual payments of $10,000 for a period of 10 years. The first payment will be made 4 years from now. If the interest rate is 5%, what is
36. Mortgage with Points. Home loans typically involve "points," which are fees charged by the lender. Each point charged means that the borrower must pay 1% of the loan amount as a fee. For example,
37. Amortizing Loan. You take out a 30-year $100,000 mortgage loan with an APR of 6% and monthly payments. In 12 years you decide to sell your house and pay off the mortgage. What is the principal
38. Amortizing Loan. Consider a 4-year amortizing loan. You borrow $1,000 initially, and repay it in four equal annual year-end payments. (LO3)a. If the interest rate is 8%, show that the annual
39. Annuity Value. You've borrowed $4,248.68 and agreed to pay back the loan with monthly payments of $200. If the interest rate is 12% stated as an APR, how long will it take you to pay back the
40. Annuity Value. The $40 million lottery payment that you just won actually pays $2 million per year for 20 years. If the discount rate is 8% and the first payment comes in I year, what is the
41. Real Annuities. A retiree wants level consumption in real terms over a 30-year retirement. If the inflation rate equals the interest rate she earns on her $450,000 of savings, how much can she
42. EAR versus APR. You invest $1,000 at a 6% annual interest rate, stated as an APR. Interest is compounded monthly. How much will you have in 1 year? In 1.5 years? (LO5)
43. Annuity Value. You just borrowed $100,000 to buy a condo. You will repay the loan in equal monthly payments of $804.62 over the next 30 years. What monthly interest rate are you paying on the
44. EAR. If a bank pays 6% interest with continuous compounding, what is the effective annual rate? (LO5)
45. Annuity Values. You can buy a car that is advertised for $24,000 on the following terms: (a) pay $24,000 and receive a $2,000 rebate from the manufacturer; (b) pay $500 a month for 4 years for
46. Continuous Compounding. How much will $100 grow to if invested at a continuously com- pounded interest rate of 10% for 8 years? What if it is invested for 10 years at 8%? (L05)
47. Future Values. I now have $20,000 in the bank earning interest of .5% per month. I need $30,000 to make a down payment on a house. I can save an additional $100 per month. How long will it take
48. Perpetuities. A local bank advertises the following deal: "Pay us $100 a year for 10 years and then we will pay you (or your beneficiaries) $100 a year forever." Is this a good deal if the inter-
49. Perpetuities. A local bank will pay you $100 a year for your lifetime if you deposit $2,500 in the bank today. If you plan to live forever, what interest rate is the bank paying? (LO4)
50. Perpetuities. A property will provide $10,000 a year forever. If its value is $125,000, what must be the discount rate? (LO4)
51. Applying Time Value. You can buy property today for $3 million and sell it in 5 years for $4 million. (You earn no rental income on the property.) (LO3)a. If the interest rate is 8%, what is the
52. Applying Time Value. A factory costs $400,000. You forecast that it will produce cash inflows of $120,000 in year 1, $180,000 in year 2, and $300,000 in year 3. The discount rate is 12%. Is the
53. Applying Time Value. You invest $1,000 today and expect to sell your investment for $2,000 in 10 years. (LOI)a. Is this a good deal if the discount rate is 6%?b. What if the discount rate is 10%?
54. Calculating Interest Rate. A store will give you a 3% discount on the cost of your purchase if you pay cash today. Otherwise, you will be billed the full price with payment due in 1 month. What
55. Quoting Rates. Banks sometimes quote interest rates in the form of "add-on interest." In this case, if a 1-year loan is quoted with a 20% interest rate and you borrow $1,000, then you pay back
56. Compound Interest. Suppose you take out a $1,000, 3-year loan using add-on interest (see previous problem) with a quoted interest rate of 20% per year. What will your monthly pay- ments be?
57. Calculating Interest Rate. What is the effective annual rate on a 1-year loan with an interest rate quoted on a discount basis (see Practice Problem 26) of 20%? (LO4)
58. Effective Rates. First National Bank pays 6.2% interest compounded semiannually. Second National Bank pays 6% interest, compounded monthly. Which bank offers the higher effective annual rate?
60. Retirement Savings. You believe you will need to have saved $500,000 by the time you retire in 40 years in order to live comfortably. If the interest rate is 6% per year, how much must you save
61. Retirement Savings. How much would you need in the previous problem if you believe that you will inherit $100,000 in 10 years? (LO3)
62. Retirement Savings. You believe you will spend $40,000 a year for 20 years once you retire in 40 years. If the interest rate is 6% per year, how much must you save each year until retirement to
63. Retirement Planning. A couple thinking about retirement decide to put aside $3,000 each year in a savings plan that earns 8% interest. In 5 years they will receive a gift of $10,000 that also can
64. Retirement Planning. 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% interest on
65. Real versus Nominal Dollars. An engineer in 1950 was earning $6,000 a year. Today she earns $60,000 a year. However, on average, goods today cost 6.9 times what they did in 1950. What is her real

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