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fundamentals of financial management

Questions and Answers of Fundamentals Of Financial Management

Describe three ratios that relate a firm's stock price to its earnings, cash flow, and book value per share, and write out their equations.AppendixLO1
How do market value ratios reflect what investors think about a stock's risk and expected rate of return?AppendixLO1
What does the price/earnings (P/E) ratio show? If one firm's P/E ratio is lower than that of another, what are some factors that might explain the difference?AppendixLO1
How is book value per share calculated? Explain how inflation and "goodwill"could cause book values to deviate from market values.AppendixLO1
How does one do a trend analysis?AppendixLO1
What important information does a trend analysis provide?AppendixLO1
Explain how the extended Du Pont equation can be used to reveal the basic determinants of ROE.AppendixLO1
What is the equity multiplier?AppendixLO1
How can management use the extended Du Pont equation to analyze ways of improving the firm's performance?AppendixLO1
Differentiate between trend analysis and comparative ratio analysis.Why is it useful to do a comparative ratio analysis?AppendixLO1
What is benchmarking?AppendixLO1
List three types of users of ratio analysis. Would the different users emphasize the same or different types of ratios? Explain.AppendixLO1
List several potential problems with ratio analysis.AppendixLO1
If a firm takes steps to improve its ROE, does this mean that shareholder wealth will also increase? Explain.AppendixLO1
What are some qualitative factors analysts should consider when evaluating a company's likely future financial performance?AppendixLO1
Financial ratio analysis is conducted by four groups of analysts: managers, equity investors, long-term creditors, and short-term creditors. WTiat is the primary emphasis of each of" these groups in
Why would the inventor}- turnover ratio be more important when analyzing a grocery chain than an insurance company?AppendixLO1
Over the past year. M. D. Ryngaert & Co. has realized an increase in its current ratio and a drop in its total assets turnover ratio. However, the company's sales, cash and marketable securities.DSO,
Profit margins and turnover ratios van- from one industry to another. What differences would vou expect"to find between a grocery chain and a steel company? Think particularly about the turnover
How does inflation distort ratio analysis comparisons, both for one company over time (trend analysis) and when different companies are compared? Are only balance sheet items or both balance sheet
If a firm's ROE is low and management wants to improve it, explain how using more debt might help.AppendixLO1
How might (a) seasonal factors and (b) different growth rates distort a comparative ratio analy- sis? Give some examples. How might these problems be alleviated?AppendixLO1
Why is it sometimes misleading to compare a company's financial ratios with those of other firms that operate in the same industry?AppendixLO1
Indicate the effects of the transactions listed in the following table on total current assets, cur- rent ratio, and net income. Use (+) to indicate an increase, (-) to indicate a decrease, and (0)
Johnson Electric doubled its EVA last year, yet its return on equity declined. What could explain these changes?AppendixLO1
Briefly explain the fundamental trade-off between risk and return.AppendixLO1
What do the slopes of the risk-return lines illustrated in Figure 8.1 indicate?AppendixLO1
Does the average investor’s willingness to take on risk vary over time? Explain.AppendixLO1
What do you think the average investor’s risk perception is now? In what types of investments do you think the average investor is investing currently?AppendixLO1
Should companies completely avoid high-risk projects? Explain.AppendixLO1
Set up an illustrative probability distribution table for an investment with probabilities for different conditions, returns under those conditions, andthe expectedreturn.AppendixLO1
Which of the two stocks graphed in Figure 8.3 is less risky? Why?AppendixLO1
Explain why you agree or disagree with this statement:Most investors are risk-averse.AppendixLO1
An investment has a 50% chance of producing a 20% return, a 25% chance of producing an 8% return, and a 25% chance of producing a −12% return. What is its expected return?AppendixLO1
What is an average-risk stock? What is the beta of such a stock?AppendixLO1
Why is it argued that beta is the best measure of a stock’s risk?AppendixLO1
An investor has a two-stock portfolio with $25,000 invested in Stock X and$50,000 invested in Stock Y. X’s beta is 1.50, and Y’s beta is 0.60. What is the beta of the investor’s
Differentiate between a stock’s expected rate of return (r); required rate of return (r);and realized, after-the-fact historical return (r). Which would have to be larger to induce you to buy the
What are the differences between the relative volatility graph (Figure 8.7), where“betas are made,” and the SML graph (Figure 8.8), where “betas are used”?Explain how both graphs are
What would happen to the SML graph in Figure 8.8 if expected inflation increased or decreased?AppendixLO1
How can a firm influence the size of its beta?AppendixLO1
A stock has a beta of 1.2. Assume that the risk-free rate is 4.5% and the market risk premium is 5%. What is the stock’s required rate of return?AppendixLO1
Have there been any studies that question the validity of the CAPM? Explain.AppendixLO1
Explain the following statement: The stand-alone risk of an individual corporate project may be quite high; but viewed in the context of its effect on stockholders’risk, the project’s true risk
How does the correlation between returns on a project and returns on the firm’s other assets affect the project’s risk?AppendixLO1
What are some important concepts for individual investors to consider when evaluating the risk and returns of various investments?AppendixLO1
KEY TERMS Define each of the following terms using graphs or equations to illustrate your answers whenever feasible:a. Risk; stand-alone risk; probability distributionb. Expected rate of return, rc.
REALIZED RATES OF RETURN Stocks A and B have the following historical returns:Year Stock A’s Returns, rA Stock B’s Returns, rB 2009 (24.25%) 5.50%2010 18.50 26.73 2011 38.67 48.25 2012 14.33
BETA AND THE REQUIRED RATE OF RETURN ECRI Corporation is a holding company with four main subsidiaries. The percentage of its capital invested in each of the subsidiaries(and their respective betas)
Suppose you owned a portfolio consisting of $250,000 of long-term U.S. government bonds.a. Would your portfolio be riskless? Explain.b. Now suppose the portfolio consists of $250,000 of 30-day
The probability distribution of a less risky expected return is more peaked than that of a riskier return. What shape would the probability distribution be for (a) completely certain returns and (b)
Is it possible to construct a portfolio of real-world stocks that has a required return equal to the risk-free rate? Explain.AppendixLO1
Stock A has an expected return of 7%, a standard deviation of expected returns of 35%, a correlation coefficient with the market of −0 3, and a beta coefficient of −0 5. Stock B has an expected
A stock had a 12% return last year, a year when the overall stock market declined. Does this mean that the stock has a negative beta and thus very little risk if held in a
If investors’ aversion to risk increased, would the risk premium on a high-beta stock increase by more or less than that on a low-beta stock? Explain.AppendixLO1
If a company’s beta were to double, would its required return also double?AppendixLO1
In Chapter 7, we saw that if the market interest rate, rd, for a given bond increased, the price of the bond would decline. Applying this same logic to stocks, explain (a) how a decrease in risk
EXPECTED RETURN A stock’s returns have the following distribution:Demand for the Company’s Products Probability of This Demand Occurring Rate of Return if This Demand Occurs Weak 0.1 (50%)Below
PORTFOLIO BETA An individual has $35,000 invested in a stock with a beta of 0 8 and another $40,000 invested in a stock with a beta of 1 4. If these are the only two investments in her portfolio,
REQUIRED RATE OF RETURN Assume that the risk-free rate is 6% and the required return on the market is 13%. What is the required rate of return on a stock with a beta of 0 7?AppendixLO1
EXPECTED AND REQUIRED RATES OF RETURN Assume that the risk-free rate is 5% and the market risk premium is 6%. What is the required return for the overall stock market? What is the required rate of
BETA AND REQUIRED RATE OF RETURN A stock has a required return of 11%, the risk-free rate is 7%, and the market risk premium is 4%.a. What is the stock’s beta?b. If the market risk premium
EXPECTED RETURNS Stocks X and Y have the following probability distributions of expected future returns:Probability X Y 0.1 (10%) (35%)0.2 2 0 0.4 12 20 0.2 20 25 0.1 38 45a. Calculate the expected
PORTFOLIO REQUIRED RETURN Suppose you are the money manager of a $4 million investment fund. The fund consists of four stocks with the following investments and betas:Stock Investment Beta A $
BETA COEFFICIENT Given the following information, determine the beta coefficient for Stock J that is consistent with equilibrium: rJ 12 5%; rRF 4 5%; rM 10 5%.AppendixLO1
REQUIRED RATE OF RETURN Stock R has a beta of 1 5, Stock S has a beta of 0 75, the required return on an average stock is 13%, and the risk-free rate of return is 7%. By howmuch does the required
CAPM AND REQUIRED RETURN Bradford Manufacturing Company has a beta of 1 45, while Farley Industries has a beta of 0 85. The required return on an index fund that holds the entire stock market is 12
CAPM AND REQUIRED RETURN Calculate the required rate of return for Manning Enterprises assuming that investors expect a 3 5% rate of inflation in the future. The real risk-free rate is 2 5%, and the
REQUIRED RATE OF RETURN Suppose rRF 9%, rM 14%, and bi 1 3.a. What is ri, the required rate of return on Stock i?b. Now suppose that rRF (1) increases to 10% or (2) decreases to 8%. The slope of the
CAPM, PORTFOLIO RISK, AND RETURN Consider the following information for Stocks X, Y, and Z. The returns on the three stocks are positively correlated, but they are not perfectly correlated. (That is,
PORTFOLIO BETA Suppose you held a diversified portfolio consisting of a $7,500 investment in each of 20 different common stocks. The portfolio’s beta is 1 12. Now suppose you decided to sell one of
CAPM AND REQUIRED RETURN HR Industries (HRI) has a beta of 1 8, while LR Industries’(LRI) beta is 0 6. The risk-free rate is 6%, and the required rate of return on an average stock is 13%. The
CAPM AND PORTFOLIO RETURN You have been managing a $5 million portfolio that has a beta of 1 25 and a required rate of return of 12%. The current risk-free rate is 5 25%.Assume that you receive
PORTFOLIO BETA A mutual fund manager has a $20 million portfolio with a beta of 1 5.The risk-free rate is 4 5%, and the market risk premium is 5 5%. The manager expects to receive an additional $5
EXPECTED RETURNS Suppose you won the lottery and had two options: (1) receiving$0 5 million or (2) taking a gamble in which at the flip of a coin you receive $1 million if a head comes up but receive
EVALUATING RISK AND RETURN Stock X has a 10% expected return, a beta coefficient of 0 9, and a 35% standard deviation of expected returns. Stock Y has a 12 5% expected return, a beta coefficient of 1
REALIZED RATES OF RETURN Stocks A and B have the following historical returns:Year Stock A’s Returns, rA Stock B’s Returns, rB 2009 (18.00%) (14.50%)2010 33.00 21.80 2011 15.00 30.50 2012 (0.50)
SECURITY MARKET LINE You plan to invest in the Kish Hedge Fund, which has total capital of $500 million invested in five stocks:Stock Investment Stock’s Beta Coefficient A $160 million 0.5 B 120
EVALUATING RISK AND RETURN Bartman Industries’ and Reynolds Inc.’s stock prices and dividends, along with the Winslow 5000 Index, are shown here for the period 2008–2013.The Winslow 5000 data
RISK AND RETURN Assume that you recently graduated with a major in finance. You just landed a job as a financial planner with Merrill Finch Inc., a large financial services corporation. Your first
What is the preemptive right, and what are the two primary reasons for its existence?AppendixLO1
What are some reasons a company might use classified stock?AppendixLO1
What is the difference between a stock’s price and its intrinsic value?AppendixLO1
Why do investors and managers need to understand how to estimate a firm’s intrinsic value?AppendixLO1
What are two commonly used approaches for estimating a stock’s intrinsic value? How do they differ in their focus?AppendixLO1
If D1 = $2.00, g = 6%, and P0 = $40.00,what are the stock’s expected dividend yield, capital gains yield, and total expected return for the coming year? (5%, 6%, 11%)AppendixLO1
Is it necessary for all investors to have the same expectations regarding a stock for the stock to be in equilibrium?AppendixLO1
What would happen to a stock’s price if the “marginal investor” examined a stock and concluded that its intrinsic value was greater than its current market price?AppendixLO1
Describe how the formula for a zero growth stock can be derived from the formula for a normal constant growth stock.AppendixLO1
Firm A is expected to pay a dividend of $1.00 at the end of the year. The required rate of return is rs = 11%. Other things held constant, what would the stock’s price be if the growth rate was 5%?
Explain how one would find the value of a nonconstant growth stock.AppendixLO1
Explain what is meant by horizon (terminal) date and horizon (continuing) value.AppendixLO1
Write out the equation for free cash flows and explain it.AppendixLO1
Why might someone use the corporate valuation model for companies that have a history of paying dividends?AppendixLO1
What steps are taken to find a stock price using the corporate model?AppendixLO1
Why might the calculated intrinsic value differ from the stock’s current market price? Which would be “correct,” and what does “correct” mean?AppendixLO1
Is the equation used to value preferred stock more like the one used to value a bond or the one used to value a “normal” constant growth common stock?Explain.AppendixLO1
KEY TERMS Define the following terms:a. Proxy; proxy fight; takeoverb. Preemptive rightc. Classified stock; founders’ sharesd. Marginal investor; intrinsic value (P^0); market price (P0)e. Required
STOCK GROWTH RATES AND VALUATION You are considering buying the stocks of two companies that operate in the same industry. They have very similar characteristics except for their dividend payout
CONSTANT GROWTH STOCK VALUATION Fletcher Company’s current stock price is$36 00, its last dividend was $2 40, and its required rate of return is 12%. If dividends are expected to grow at a constant

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