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fundamentals of corporate finance

Questions and Answers of Fundamentals Of Corporate Finance

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 percent?How high can
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 be
Profitability Index. What is the profitability index of a project that costs $10,000 and provides cash flows of $3,000 in Years 1 and 2 and $5,000 in Years 3 and 4? The discount rate is 10 percent.
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 decommissioned at
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? Cash Flows, Dollars Project Co C C2 NPV at 10% A -30,000
IRR. You have the chance to participate in a project that produces the following cash flows:The internal rate of return is 13.6 percent. If the opportunity cost of capital is 12 percent, would you
NPV/IRR.a. Calculate the net present value of the following project for discount rates of 0, 50, and 100 percent:b. What is the IRR of the project? Co C C2 -$6,750 +$4,500 +$18,000
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 installing if
Investment Criteria. If you insulate your office for $1,000, you will save $100 a year in heating expenses. These savings will last forever.a. What is the NPV of the investment when the cost of
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.b. What is the
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?
IRR/NPV. Consider this project with an internal rate of return of 13.1 percent. Should you accept or reject the project if the discount rate is 12 percent? Year Cash Flow 0 +$100 12 1 -60 -60
Payback and NPV.a. What is the payback period on each of the following projects?b. Given that you wish to use the payback rule with a cutoff period of 2 years, which projects would you accept?c. If
Book Rate of Return. Consider these data on a proposed project:Original investment = $200 Straight-line depreciation of $50 a year for 4 years Project life = 4 yearsa. Fill in the blanks in the
Book Rate of Return. A machine costs $8,000 and is expected to produce profit before depreciation of $2,500 in each of Years 1 and 2 and $3,500 in each of Years 3 and 4. Assuming that the machine is
Book Rate of Return. A project requires an initial investment of $10,000, and over its 5-year life it will generate annual cash revenues of $5,000 and cash expenses of $2,000. The firm will use
Profitability Index. Consider the following projects:a. Calculate the profitability index for A and B assuming a 20 percent opportunity cost of capital.b. Use the profitability index rule to
Capital Rationing. You are a manager with an investment budget of $8 million. You may invest in the following projects. Investment and cash-flow figures are in millions of dollars.a. Why might these
Mutually Exclusive Investments. Here are the cash flow forecasts for two mutually exclusive projects:a. Which project would you choose if the opportunity cost of capital is 2 percent?b. Which would
Equivalent Annual Cost. A precision lathe costs $10,000 and will cost $20,000 a year to operate and maintain. If the discount rate is 12 percent and the lathe will last for five years, what is the
Equivalent Annual Cost. 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 truck will
Multiple IRR. Consider the following cash flows:a. Confirm that one internal rate of return on this project is (a shade above) 7 percent, and that the other is (a shade below) 34 percent.b. Is the
Equivalent Annual Cost. Econo-cool air conditioners cost $300 to purchase, result in electricity bills of $150 per year, and last for 5 years. Luxury Air models cost $500, result in electricity bills
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 decrease
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 that
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 which can last for 10 years and should require maintenance
NPV/IRR. Growth Enterprises believes its latest project, which will cost $80,000 to install, will generate a perpetual growing stream of cash flows. Cash flow at the end of this year will be $5,000,
Investment Timing. A classic problem in management of forests is determining when it is most economically advantageous to cut a tree for lumber. When the tree is young, it grows very rapidly. As it
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 $28
Cash Flows. A new project will generate sales of $74 million, costs of $42 million, and depreciation expense of $10 million in the coming year. The firm’s tax rate is 35 percent. Calculate cash
Cash Flows. Canyon Tours showed the following components of working capital last year:a. What was the change in net working capital during the year?b. If sales were $36,000 and costs were $24,000,
Cash Flows. Tubby Toys estimates that its new line of rubber ducks will generate sales of$7 million, operating costs of $4 million, and a depreciation expense of $1 million. If the tax rate is 40
Cash Flows. We’ve emphasized that the firm should pay attention only to cash flows when assessing the net present value of proposed projects. Depreciation is a noncash expense.Why then does it
Proper Cash Flows. Quick Computing currently sells 10 million computer chips each year at a price of $20 per chip. It is about to introduce a new chip, and it forecasts annual sales of 12 million of
Calculating Net Income. The owner of a bicycle repair shop forecasts revenues of $160,000 a year. Variable costs will be $45,000, and rental costs for the shop are $35,000 a year. Depreciation on the
Cash Flows. Calculate the operating cash flow for the repair shop in the previous problem using all three methods suggested in the material: (a) net income plus depreciation; (b) cash inflow/cash
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 in
Incremental Cash Flows. A corporation donates a valuable painting from its private collection to an art museum. Which of the following are incremental cash flows associated with the donation?a. The
Operating Cash Flows. Laurel’s Lawn Care, Ltd., has a new mower line that can generate revenues of $120,000 per year. Direct production costs are $40,000 and the fixed costs of maintaining the lawn
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.a. Find the depreciation
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 almost
Cash Flows and Working Capital. A firm had net income last year of $1.2 million. Its depreciation expenses were $.5 million, and its total cash flow was $1.2 million. What happened to net working
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. What
Cash Flows and Working Capital. A firm’s balance sheets for year-end 2000 and 2001 contain the following data. What happened to investment in net working capital during 2001? All items are in
Salvage Value. Quick Computing (from problem 5) installed its previous generation of computer chip manufacturing equipment 3 years ago. Some of that older equipment will become unnecessary when the
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 million at the completion of
Depreciation and Project Value. Bottoms Up Diaper Service is considering the purchase of a new industrial washer. It can purchase the washer for $6,000 and sell its old washer for$2,000. The new
Equivalent Annual Cost. What is the equivalent annual cost of the washer in the previous problem if the firm uses straight-line depreciation?
Cash Flows and NPV. Johnny’s Lunches is considering purchasing a new, energy-efficient grill. The grill will cost $20,000 and will be depreciated according to the 3-year MACRS schedule. It will be
Project Evaluation. Revenues generated by a new fad product are forecast as follows:Expenses are expected to be 40 percent of revenues, and working capital required in each year is expected to be 20
Buy versus Lease. You can buy a car for $25,000 and sell it in 5 years for $5,000. Or you can lease the car for 5 years for $5,000 a year. The discount rate is 10 percent per year.a. Which option do
Project Evaluation. Kinky Copies may buy a high-volume copier. The machine costs$100,000 and will be depreciated straight-line over 5 years to a salvage value of $20,000.Kinky anticipates that the
Project Evaluation. Blooper Industries must replace its magnoosium purification system.Quick & Dirty Systems sells a relatively cheap purification system for $10 million. The system will last 5
Project Evaluation. The following table presents sales forecasts for Golden Gelt Giftware.The unit price is $40. The unit cost of the giftware is $25.It is expected that net working capital will
Project Evaluation. Ilana Industries, Inc., needs a new lathe. It can buy a new high-speed lathe for $1 million. The lathe will cost $35,000 to run, will save the firm $125,000 in labor costs, and
Project Evaluation. The efficiency gains resulting from a just-in-time inventory management system will allow a firm to reduce its level of inventories permanently by $250,000.What is the most the
Project Evaluation. Better Mousetraps has developed a new trap. It can go into production for an initial investment in equipment of $6 million. The equipment will be depreciated straight line over 5
Working Capital Management. Return to the previous problem. Suppose the firm can cut its requirements for working capital in half by using better inventory control systems. By how much will this
Project Evaluation. PC Shopping Network may upgrade its modem pool. It last upgraded 2 years ago, when it spent $115 million on equipment with an assumed life of 5 years and an assumed salvage value
Risk and Return. True or false? Explain or qualify as necessary.a. Investors demand higher expected rates of return on stocks with more variable rates of return.b. The capital asset pricing model
Diversifiable Risk. In light of what you’ve learned about market versus diversifiable(unique) risks, explain why an insurance company has no problem in selling life insurance to individuals but is
Unique vs. Market Risk. Figure 4.14 plots monthly rates of return from 1993 to 1999 for the Snake Oil mutual fund. Was this fund well-diversified? Explain.
Risk and Return. Suppose that the risk premium on stocks and other securities did in factrise with total risk (that is, the variability of returns) rather than just market risk. Explain how investors
CAPM and Hurdle Rates. A project under consideration has an internal rate of return of 14 percent and a beta of .6. The risk-free rate is 5 percent and the expected rate of return on the market
CAPM and Valuation. You are considering acquiring a firm that you believe can generate expected cash flows of $10,000 a year forever. However, you recognize that those cash flows are uncertain.a.
CAPM and Expected Return. If the risk-free rate is 6 percent and the expected rate of return on the market portfolio is 14 percent, is a security with a beta of 1.25 and an expected rate of return of
Using Beta. Investors expect the market rate of return this year to be 14 percent. A stock with a beta of .8 has an expected rate of return of 12 percent. If the market return this year turns out to
Unique vs. Market Risk. Figure 4.15 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 plot.a.
Calculating Beta. Following are several months’ rates of return for Tumblehome Canoe Company. Prepare a plot like Figure 4.7. What is Tumblehome’s beta? (c) 25 22 20 15 10 Nike return, percent 5
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.a. Find the beta of
CAPM and Cost of Capital. Draw the security market line when the Treasury bill rate is 10 percent and the market risk premium is 8 percent. What are the project costs of capital for new ventures with
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:Based on the behavior of the
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 with
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 percent, and the market risk premium is 8
CAPM and Expected Return. Reconsider the stock in the preceding problem. Suppose investors actually believe the stock will sell for $54 at year-end. Is the stock a good or bad buy? What will
Portfolio Risk and Return. Suppose that the S&P 500, with a beta of 1.0, has an expected return of 13 percent and T-bills provide a risk-free return of 5 percent.a. What would be the expected return
Portfolio Risk and Return. Suppose that the S&P 500, with a beta of 1.0, has an expected return of 15 percent and T-bills provide a risk-free return of 5 percent.a. How would you construct a
CAPM and Valuation. You are considering the purchase of real estate which will provide perpetual income that should average $50,000 per year. How much will you pay for the property if you believe its
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 in vestors be willing to
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 percent.
CAPM and Expected Return. Stock A has a beta of .5 and investors expect it to return 5 percent. Stock B has a beta of 1.5 and investors expect it to return 13 percent. Use the CAPM to find the market
CAPM and Expected Return. If the expected rate of return on the market portfolio is 14 percent and T-bills yield 6 percent, what must be the beta of a stock that investors expect to return 10 percent?
Project Cost of Capital. Suppose General Mills is considering a new investment in the common stock of a publishing company. Which of the betas shown in the table in problem 21 is most relevant in
Risk and Return. True or false? Explain or qualify as necessary.a. The expected rate of return on an investment with a beta of 2 is twice as high as the expected rate of return of the market
CAPM and Expected Return. A mutual fund manager expects her portfolio to earn a rate of return of 12 percent this year. The beta of her portfolio is .8. If the rate of return available on risk-free
Required Rate of Return. Reconsider the mutual fund manager in the previous problem.Explain how you would use a stock index mutual fund and a risk-free position in Treasury bills (or a money market
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
CAPM. We Do Bankruptcies is a law firm that specializes in providing advice to firms in financial distress. It prospers in recessions when other firms are struggling. Consequently, its beta is
Leverage and Portfolio Risk. Footnote 4 in the material asks you to consider a borrow-andinvest strategy in which you use $1 million of your own money and borrow another $1 million to invest $2
Cost of Debt. Micro Spinoffs, Inc., issued 20-year debt a year ago at par value with a coupon rate of 9 percent, paid annually. Today, the debt is selling at $1,050. If the firm’s tax bracket is 35
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?
Calculating WACC. Suppose Micro Spinoffs’s cost of equity is 12.5 percent. What is its WACC if equity is 50 percent, preferred stock is 20 percent, and debt is 30 percent of total capital?
Cost of Equity. Reliable Electric is a regulated public utility, and it is expected to provide steady growth of dividends of 5 percent per year for the indefinite future. Its last dividend was $5 per
Calculating WACC. Reactive Industries has the following capital structure. Its corporate tax rate is 35 percent. What is its WACC? Security Market Value Required Rate of Return Debt $20 million 8%
Company versus Project Discount Rates. Geothermal’s WACC is 11.4 percent. Executive Fruit’s WACC is 12.3 percent. Now Executive Fruit is considering an investment in geothermal power production.
Flotation Costs. A project costs $10 million and has NPV of $+2.5 million. The NPV is computed by discounting at a WACC of 15 percent. Unfortunately, the $10 million investment will have to be raised
WACC. The common stock of Buildwell Conservation & Construction, Inc., has a beta of.80. The Treasury bill rate is 4 percent and the market risk premium is estimated at 8 percent.BCCI’s capital
WACC and NPV. BCCI (see the previous problem) is evaluating a project with an internal rate of return of 12 percent. Should it accept the project? If the project will generate a cash flow of $100,000
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
WACC. Nodebt, Inc., is a firm with all-equity financing. Its equity beta is .80. The Treasury bill rate is 5 percent and the market risk premium is expected to be 10 percent. What is Nodebt’s asset

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