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principles corporate finance

Questions and Answers of Principles Corporate Finance

• Why did we determine income when NPV analysis discounts cash flows, not income?
• What are the items leading to cash flow in any year?
• Define sunk costs, opportunity costs, and side effects.
• What are the three difficulties in determining incremental cash flows?
3. Suppose the Innovative Motors Corporation (IMC) is determining the NPV of a new convertible sports car. Some of the customers who would purchase the car are owners of IMC’s compact sedan. Are
2. Suppose the Weinstein Trading Company has an empty warehouse in Philadelphia that can be used to store a new line of electronic pinball machines. The company hopes to market the machines to
1. The General Milk Company is currently evaluating the NPV of establishing a line of chocolate milk. As part of the evaluation the company had paid a consulting firm $100,000 to perform a
A.3 If the one-year spot rate is 9 percent and the two-year spot rate is 10 percent, what is the forward rate?
A.2 The one-year spot rate equals 10 percent and the two-year spot rate equals 8 percent. What should a 5-percent coupon two-year bond cost?
A.1 The appropriate discount rate for cash flows received one year from today is 10 percent. The appropriate annual discount rate for cash flows received two years from today is 11 percent.a. What is
5.32 (Challenge Question) Lewin Skis Inc. (today) expects to earn $4.00 per share for each of the future operating periods (beginning at time 1) if the firm makes no new investments(and returns the
5.31 Consider Pacific Energy Company and U.S. Bluechips, Inc., both of which reported recent earnings of $800,000 and have 500,000 shares of common stock outstanding. Assume both firms have the same
5.30 The Webster Co. has just paid a dividend of $5.25 per share. The company will increase its dividend by 15 percent next year and will then reduce its dividend growth by 3 percent each year until
5.29 Four years ago, Ultramar Diamond Inc. paid a dividend of $0.80 per share. This year Ultramar paid a dividend of $1.66 per share. It is expected that the company will pay dividends growing at the
5.28 In order to buy back its own shares, Pennzoil Co. has decided to suspend its dividends for the next two years. It will resume its annual cash dividend of $2.00 a share 3 years from now. This
5.27 Suppose Smithfield Foods, Inc., has just paid a dividend of $1.40 per share. Sales and profits for Smithfield Foods are expected to grow at a rate of 5% per year. Its dividend is expected to
5.26 California Electronics, Inc., expects to earn $100 million per year in perpetuity if it does not undertake any new projects. The firm has an opportunity that requires an investment of$15 million
5.25 Rite Bite Enterprises sells toothpicks. Gross revenues last year were $3 million, and total costs were $1.5 million. Rite Bite has 1 million shares of common stock outstanding.Gross revenues and
5.24 Von Neumann Enterprises has just reported earnings of $10 million, and it plans to retain 75 percent of its earnings. The company has 1.25 million shares of common stock outstanding.The stock is
5.23 The newspaper reported last week that Bradley Enterprises earned $20 million. The report also stated that the firm’s return on equity remains on its historical trend of 14 percent.Bradley
5.22 The Highest Potential, Inc., will pay a quarterly dividend per share of $1 at the end of each of the next 12 quarters. Subsequently, the dividend will grow at a quarterly rate of 0.5 percent
5.21 Calamity Mining Company’s reserves of ore are being depleted, and its costs of recovering a declining quantity of ore are rising each year. As a result, the company’s earnings are declining
5.20 Allen, Inc., is expected to pay an equal amount of dividends at the end of the first two years. Thereafter, the dividend will grow at a constant rate of 4 percent indefinitely. The stock is
5.19 Whizzkids, Inc., is experiencing a period of rapid growth. Earnings and dividends per share are expected to grow at a rate of 18 percent during the next two years, 15 percent in the third year,
5.18 Easy Type, Inc., is one of a myriad of companies selling word processor programs.Their newest program will cost $5 million to develop. First-year net cash flows will be$2 million. As a result of
5.17 Consider the stock of Davidson Company that will pay an annual dividend of $2 in the coming year. The dividend is expected to grow at a constant rate of 5 percent permanently.The market requires
5.16 You own $100,000 worth of Smart Money stock. At the end of the first year you receive a dividend of $2 per share; at the end of year 2 you receive a $4 dividend. At the end of year 3 you sell
5.13 A common stock pays a current dividend of $2. The dividend is expected to grow at an 8-percent annual rate for the next three years; then it will grow at 4 percent in perpetuity.The appropriate
5.10 The Sue Fleming Corporation has two different bonds currently outstanding. Bond A has a face value of $40,000 and matures in 20 years. The bond makes no payments for the first six years and then
5.9 Consider a bond that pays an $80 coupon annually and has a face value of $1,000.Calculate the yield to maturity if the bond hasa. 20 years remaining to maturity and it is sold at $1,200.b. 10
5.8a. If the market interest rate (the required rate of return that investors demand)unexpectedly increases, what effect would you expect this increase to have on the prices of long-term bonds?
5.7 Consider two bonds, bond A and bond B, with equal rates of 10 percent and the same face values of $1,000. The coupons are paid annually for both bonds. Bond A has 20 years to maturity while bond
5.6 You have just purchased a newly issued $1,000 five-year Vanguard Company bond at par.This five-year bond pays $60 in interest semiannually. You are also considering the purchase of another
5.5 A bond is sold at $923.14 (below its par value of $1,000). The bond has 15 years to maturity and investors require a 10-percent yield on the bond. What is the coupon rate for the bond if the
5.4 Pettit Trucking has issued an 8-percent, 20-year bond that pays interest semiannually. If the market prices the bond to yield an effective annual rate of 10 percent, what is the price of the bond?
5.3 Consider a bond with a face value of $1,000. The coupon is paid semiannually and the market interest rate (effective annual interest rate) is 12 percent. How much would you pay for the bond ifa.
5.2 Microhard has issued a bond with the following characteristics:Principal: $1,000 Term to maturity: 20 years Coupon rate: 8 percent Semiannual payments Calculate the price of the Microhard bond if
5.1 What is the present value of a 10-year, pure discount bond that pays $1,000 at maturity and is priced to yield the following rates?a. 5 percentb. 10 percentc. 15 percent
• What are the three factors determining a firm’s P/E ratio?
1. Cumberland Book Publishers has EPS of $10 at the end of the first year, a dividend-payout ratio of 40 percent, a discount rate of 16 percent, and a return on its retained earnings of 20 percent.
1. Sarro Shipping, Inc., expects to earn $1 million per year in perpetuity if it undertakes no new investment opportunities. There are 100,000 shares of stock outstanding, so earnings per share equal
1. Pagemaster Enterprises just reported earnings of $2 million. It plans to retain 40 percent of its earnings. The historical return on equity (ROE) has been 0.16, a figure that is expected to
1. Consider the stock of Elixir Drug Company, which has a new back-rub ointment and is enjoying rapid growth. The dividend for a share of stock a year from today will be $1.15. During the next four
1. Suppose an investor is considering the purchase of a share of the Utah Mining Company. The stock will pay a $3 dividend a year from today. This dividend is expected to grow at 10 percent per year
1. Hampshire Products will pay a dividend of $4 per share a year from now. Financial analysts believe that dividends will rise at 6 percent per year for the foreseeable future. What is the dividend
• How does one calculate the yield to maturity on a bond?
• What is the relationship between interest rates and bond prices?
• Contrast the stated interest rate and the effective annual interest rate for bonds paying semiannual interest.
• Define pure discount bonds, level-coupon bonds, and consols.
3.8 Consider a one-year world with perfect capital markets in which the interest rate is 10 percent. Suppose a firm has $12 million in cash. The firm invests $7 million today, and $5 million is paid
3.7a. Briefly explain why from the shareholders’ perspective it is desirable for corporations to maximize NPV.b. What assumptions are necessary for this argument to be correct?
3.6 Suppose that the person in the land-investment example in the text wants to consume$60,000 this year.a. Detail a plan of investment and borrowing or lending that would permit her to
3.3 What is the basic reason that financial markets develop?
3.2 Rich Pettit is a miser. His current income is $50,000; next year he will earn $40,000. He plans to consume only $20,000 this year. The current interest rate is 12 percent. What will Rich’s
3.1 Currently, Jim Morris makes $100,000. Next year his income will be $120,000. Jim is a big spender and he wants to consume $150,000 this year. The equilibrium interest rate is 10 percent.What will
• What information does a person need to compute an investment’s net present value?
• Give the definitions of net present value, future value, and present value.
• What is the separation theorem? Why is it important?
• Describe how the financial markets can be used to evaluate investment alternatives.
• Describe the basic financial principle of investment decision making.
• What conditions are likely to lead to this?
• What is the most important feature of a competitive financial market?
• What do we mean when we say a market clears? What is an equilibrium rate of interest?
• What are institutions that match borrowers and lenders called?
• What is an interest rate?
1. What long-term investment strategy should a company take on?
2. How can cash be raised for the required investments?
3. How much short-term cash flow does a company need to pay its bills?
4. WHAT IS CORPORATE FINANCE?
• What are three basic questions of corporate finance?
• Describe capital structure.
• How is value created?
• List the three reasons why value creation is difficult.
• What are the two types of agency costs?
• How are managers bonded to shareholders?
• Can you recall some managerial goals?
• What is the set-of-contracts perspective?
• What is listing?
• What is the balance-sheet equation?
• What three things should be kept in mind when looking at a balance sheet?
• How is cash flow different from changes in net working capital?
• What is the difference between operating cash flow and total cash flow of the firm?
• What is the income statement equation?
• What are three things to keep in mind when looking at an income statement?
• What are noncash expenses?
• What is the change in net working capital?
2.1 Prepare a December 31 balance sheet using the following data:Cash $ 4,000 Patents 82,000 Accounts payable 6,000 Accounts receivable 8,000 Taxes payable 2,000 Machinery 34,000 Bonds payable 7,000
2.2 The following table presents the long-term liabilities and stockholders’ equity of Information Control Corp. of one year ago.Long-term debt $50,000,000 Preferred stock 30,000,000 Common stock
2.3 Prepare an income statement using the following data.Sales $500,000 Cost of goods sold 200,000 Administrative expenses 100,000 Interest expense 50,000 The firm’s tax rate is 34 percent
2.5 What are the differences between accounting profit and cash flow?
2.7 The Stancil Corporation provided the following current information.Proceeds from short-term borrowing $ 6,000 Proceeds from long-term borrowing 20,000 Proceeds from the sale of common stock 1,000
You can find swap rates for the U.S. dollar and the euro on www.ft.com. Plot the current swap curves as in Figure 26.3.
Take another look at our two-step binomial trees for Amazon in Figure 21.2. Use the risk-neutral method to value six-month call and put options with an exercise price of $750. Assume the Amazon stock
Use the spreadsheet for the guano project in Chapter 6 to undertake a sensitivity analysis of the project. Make whatever assumptions seem reasonable to you. What are the critical variables? What
On October 17, 2013, an 8 year Treasury Bond with a face value of$1,000.00, paying $20.00 in coupon payments per year had a discount rate per year (yield) of 2.35%. Consider a bond that paid a $35.00
On October 17, 2013, a 4 year Treasury Bond with a face value of$1,000 and an annual coupon rate of 1.88% had a yield to maturity of 1.08%.This bond makes 2 (semi-annual) coupon payments per year and
On October 17, 2013, a 4 year Treasury Bond with a face value of$1,000 and an annual coupon rate of 1.88% had a yield to maturity of 1.08%.This bond makes 2 (semi-annual) coupon payments per year and
On October 17, 2013, a 4 year Treasury Bond with a face value of$1,000 and an annual coupon rate of 1.88% had a yield to maturity of 1.08%.This bond makes 2 (semi-annual) coupon payments per year and
There is a system of five bond variables: (1) Number of Periods to Maturity (T), (2) Face Value (PAR), (3) Discount Rate / Period (r), (4) Coupon Payments (PMT), and (5) Bond Price (P). Given any
An annual bond has a face value of $900, makes an annual coupon payment of $17.00 per year, has a discount rate per year of 5.37%, and has 10 years to maturity. What is price of this bond?

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