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principles corporate finance

Questions and Answers of Principles Corporate Finance

15. In Section 25-5 we listed four circumstances in which there are potential gains from leasing.Check them out by conducting a sensitivity analysis on the Greymare Bus Lines lease, assuming that
17. A lease with a varying rental schedule is known as a structured lease. Try structuring the Greymare Bus Lines lease to increase value to the lessee while preserving the value to the lessor.Assume
18. Nodhead College needs a new computer. It can either buy it for $250,000 or lease it from Compulease. The lease terms require Nodhead to make six annual payments (prepaid) of$62,000. Nodhead pays
19. The Safety Razor Company has a large tax-loss carryforward and does not expect to pay taxes for another 10 years. The company is therefore proposing to lease $100,000 of new machinery. The lease
21. How would the lessee in Figure 25.1 evaluate the NPV of the lease? Sketch the correct valuation procedure. Then suppose that the equity lessor wants to evaluate the lease. Again sketch the
22. Magna Charter has been asked to operate a Beaver bush plane for a mining company exploring north and west of Fort Liard. Magna will have a firm one-year contract with the mining company and
3. Yesterday you sold six-month futures on the German DAX stock market index at a price of 4,820. Today the DAX closed at 4,800 and DAX futures closed at 4,840. You get a call from your broker, who
12.a. Marshall Arts has just invested $1 million in long-term Treasury bonds. Marshall is concerned about increasing volatility in interest rates. He decides to hedge using bond futures contracts.
18. If you buy a nine-month T-bill future, you undertake to buy a three-month bill in nine months’ time. Suppose that Treasury bills and notes currently offer the following yields:Months to
19. Table 26.4 contains spot and six-month futures prices for several commodities and financial instruments. There may be some money-making opportunities. See if you can find them, and explain how
20. The following table shows 2009 gold futures prices for varying contract lengths. Gold is predominantly an investment good, not an industrial commodity. Investors hold gold because it diversifies
22. Securities A, B, and C have the following cash flows:Period 1 Period 2 Period 3 A $ 40 $40 $ 40 B $120 — —C $ 10 $10 $110a. Calculate their durations if the interest rate is 8%.b. Suppose
23. What is meant by “delta” ( ␦ ) in the context of hedging? Give examples of how delta can be estimated or calculated.
27. In Section 26-6, we stated that the duration of Potterton’s lease equals the duration of its debt.a. Show that this is so.b. Now suppose that the interest rate falls to 3%. Show how the value
29. Consider the commodities and financial assets listed in Table 26.5 . The risk-free interest rate is 6% a year, and the term structure is flat.a. Calculate the six-month futures price for each
30. Is a total return swap on a bond the same as a credit default swap (see Section 23-1)? Why or why not?
31. “Speculators want futures contracts to be incorrectly priced; hedgers want them to be correctly priced.” Why?
32. Your investment bank has an investment of $100 million in the stock of the Swiss Roll Corporation and a short position in the stock of the Frankfurter Sausage Company. Here is the recent price
33. Phillip’s Screwdriver Company has borrowed $20 million from a bank at a floating interest rate of 2 percentage points above three-month Treasury bills, which now yield 5%. Assume that interest
1. The Web sites of the major commodities exchanges provide futures prices. Calculate and plot (as in Figure 26.2) the annualized net convenience yield for a commodity of your choice. ( Note: You may
3. You can find spot and futures prices for a variety of equity indexes on www.wsj.com . Pick one and check whether it is fairly priced. You will need to do some detective work to find the dividend
4. The following table shows interest rates and exchange rates for the U.S. dollar and the Philippine peso in 2007. The spot exchange rate is 47.46 pesos $1. Complete the missing entries:1 Month 3
5. An importer in the United States is due to take delivery of clothing from Mexico in six months. The price is fixed in Mexican pesos. Which of the following transactions could eliminate the
6. A U.S. company has committed to pay 10 million kronor to a Swedish company in one year. What is the cost (in present value) of covering this liability by buying kronor forward?The Swedish interest
9. It is the year 2018 and Pork Barrels Inc. is considering construction of a new barrel plant in Spain. The forecasted cash flows in millions of euros are as follows:C0 C1 C2 C3 C4 C5 80 10 20 23 27
10. Table 27.1 shows the 90-day forward rate on the South African rand.a. Is the dollar at a forward discount or premium on the rand?b. What is the annual percentage discount or premium?c. If you
11. Look at Table 27.1 . If the three-month interest rate on dollars is 0.2%, what do you think is the three-month interest rate on South African rand? Explain what would happen if the rate were
15. A Ford dealer in the United States may be exposed to a devaluation of the yen if this leads to a cut in the price of Japanese cars. Suppose that the dealer estimates that a 1% decline in the
18. Table 27.5 above shows the annual interest rate (annually compounded) and exchange rates against the dollar for different currencies. Are there any arbitrage opportunities? If so, how would you
19. “Last year we had a substantial income in sterling, which we hedged by selling sterling forward. In the event sterling appreciated. So our decision to sell forward cost us a lot of money. I
20. Carpet Baggers, Inc., is proposing to construct a new bagging plant in a country in Europe.The two prime candidates are Germany and Switzerland. The forecasted cash flows from the proposed plants
1. Find the foreign exchange rate tables in the online versions of The Wall Street Journal( www.wsj.com ) or the Financial Times ( www.ft.com ).a. How many U.S. dollars are worth one Canadian dollar
2. Find the foreign exchange rate tables in the online versions of The Wall Street Journal( www.wsj.com ) or the Financial Times ( www.ft.com ). How many Swiss francs can you buy for $1? How many
2. Table 28.11 on the following page gives abbreviated balance sheets and income statements for Estée Lauder Companies. Calculate the following ratios:a. Return on assets.b. Operating profit
3. Look again at Table 28.11 . Calculate a common-size balance sheet and income statement for Estée Lauder.
4. Look again at Table 28.11 . At the end of fiscal 2008 Estée Lauder had 195 million shares outstanding 20 with a share price of $45.50. The company’s weighted-average cost of capital was about
6. True or false?a. A company’s debt–equity ratio is always less than 1.b. The quick ratio is always less than the current ratio.c. The return on equity is always less than the return on
10. Consider this simplified balance sheet for Geomorph Trading:Current assets $100 $ 60 Current liabilities Long-term assets 500 280 Long-term debt 70 Other liabilities 190 Equity$600 $600a.
13. On average, it takes Microlimp’s customers 60 days to pay their bills. If Microlimp has annual sales of $500 million, what is the average value of unpaid bills?INTERMEDIATE
14. This question reviews some of the difficulties encountered in interpreting accounting numbers.a. Give four examples of important assets, liabilities, or transactions that may not be shown on the
16. Discuss alternative measures of financial leverage. Should the market value of equity be used or the book value? Is it better to use the market value of debt, the book value, or the book value
18. How would the following actions affect a firm’s current ratio?a. Inventory is sold.b. The firm takes out a bank loan to pay its suppliers.c. The firm arranges a line of credit with a bank that
19. Sara Togas sells all its output to Federal Stores. The following table shows selected financial data, in millions, for the two firms:Sales Interest Payment Net Income Assets at Start of Year
20. As you can see, someone has spilled ink over some of the entries in the balance sheet and income statement of Transylvania Railroad ( Table 28.12 ). Can you use the following information to work
21. Here are some data for five companies in the same industry:Company Code A B C D E EBIT 10 30 100 3 80 Interest expense 5 15 50 2 1 You have been asked to calculate a measure of
22. How would rapid inflation affect the accuracy and relevance of a manufacturing company’s balance sheet and income statement? Does your answer depend on how much debt the firm has issued?
23. Suppose that you wish to use financial ratios to estimate the risk of a company’s stock.Which of those that we have described in this chapter are likely to be helpful? Can you think of other
24. Look up some firms that have been in trouble. Plot the changes over the preceding years in the principal financial ratios. Are there any patterns?December 2009 December 2008 Balance Sheet Cash 20
26. Sometimes analysts use the average of capital at the start and end of the year to calculate return on capital. Provide some examples to illustrate when this does and does not make sense. ( Hint:
27. Take another look at Geomorph Trading’s balance sheet in Problem 10 and consider the following additional information:Current Assets Current Liabilities Other Liabilities Cash $15 Payables $35
1. Find financial ratios for five different industries. Can you account for some of the differences between industries?
2. Select two companies that are in a similar line of business and find their simplified balance sheets and income statements. Then draw up common-size statements for each company and compute the
3. Here is a forecast of sales by National Bromide for the first four months of 2010 (figures in$ thousands):Month 1 Month 2 Month 3 Month 4 Cash sales 15 24 18 14 Sales on credit 100 120 90 70 On
4. Dynamic Futon forecasts the following purchases from suppliers:Jan. Feb. Mar. Apr. May Jun.Value of goods ($ millions) 32 28 25 22 20 20a. Forty percent of goods are supplied cash-on-delivery. The
5. Each of the following events affects one or more tables in Sections 29-2 to 29-3 . Show the effects of each event by adjusting the tables listed in parentheses:a. Dynamic repays only $10 million
7. Table 29.11 on the next page summarizes the 2011 income statement and end-year balance sheet of Drake’s Bowling Alleys. Drake’s financial manager forecasts a 10% increase in sales and costs in
8. Abbreviated financial statements for Archimedes Levers are shown in Table 29.12 on the next page. If sales increase by 10% in 2011 and all other items, including debt, increase correspondingly,
9. What is the maximum possible growth rate for Archimedes (see Problem 8 ) if the payout ratio is set at 50% and ( a ) no external debt or equity is to be issued? (b) the firm maintains a fixed debt
10. Table 29.13 (on the next page) lists data from the budget of Ritewell Publishers. Half the company’s sales are for cash on the nail; the other half are paid for with a one-month delay.The
12. Which items in Table 29.6 would be affected by the following events?a. There is a rise in interest rates.b. Suppliers demand interest for late payment.c. Dynamic receives an unexpected bill in
13. Table 29.15 (on the next page) shows Dynamic Mattress’s year-end 2007 balance sheet, and Table 29.16 (on page 754) shows its income statement for 2008. Work out the statement of cash flows for
14. Work out a short-term financing plan for Dynamic Mattress Company, assuming the limit on the line of credit is raised from $100 to $120 million. Otherwise keep to the assumptions used in
15. Dynamic Mattress decides to lease its new mattressstuffing machines rather than buy them. As a result, capital expenditure in the first quarter is reduced by$50 million, but the company must make
19. Construct a new model for Dynamic Mattress based on your answer to Problem 18 . Does your model generate a feasible financial plan for 2010? ( Hint: If it doesn’t, you may have to allow the
20.a. Use the Dynamic Mattress model ( Tables 29.8 – 29.10 ) and the “live” spreadsheets on the book’s Web site at www.mhhe.com/bma to produce pro forma income statements, balance sheets, and
21. The financial statements of Eagle Sport Supply are shown in Table 29.17 (on the next page). For simplicity, “Costs” include interest. Assume that Eagle’s assets are proportional to its
22.a. What is the internal growth rate of Eagle Sport (see Problem 21 ) if the dividend payout ratio is fixed at 60% and the equity-to-asset ratio is fixed at two-thirds?b. What is the sustainable
23. Bio-Plasma Corp. is growing at 30% per year. It is all-equity-financed and has total assets of $1 million. Its return on equity is 20%. Its plowback ratio is 40%.a. What is the internal growth
6. Look back at the discussion in Section 30-2 of credit decisions with repeat orders. If p 1 ⫽ .8, what is the minimum level of p 2 at which Cast Iron is justified in extending credit?
12. In October 2008, six-month (182-day) Treasury bills were issued at a discount of 1.4%.What is the annual yield?
17. Listed below are some common terms of sale. Can you explain what each means?a. 2/30, net 60.b. 2/5, EOM, net 30.c. COD.
18. Some of the items in Problem 17 involve a cash discount. For each of these, calculate the rate of interest paid by customers who pay on the due date instead of taking the cash discount.
19. Phoenix Lambert currently sells its goods cash-on-delivery. However, the financial manager believes that by offering credit terms of 2/10 net 30 the company can increase sales by 4%, without
20. As treasurer of the Universal Bed Corporation, Aristotle Procrustes is worried about his bad debt ratio, which is currently running at 6%. He believes that imposing a more stringent credit policy
21. Jim Khana, the credit manager of Velcro Saddles, is reappraising the company’s credit policy. Velcro sells on terms of net 30. Cost of goods sold is 85% of sales, and fixed costs are a further
22. Look again at Problem 21 . Suppose (a) that it costs $95 to classify each new credit applicant and (b) that an almost equal proportion of new applicants falls into each of the four categories.In
23. Until recently, Augean Cleaning Products sold its products on terms of net 60, with an average collection period of 75 days. In an attempt to induce customers to pay more promptly, it has changed
24. Look back at Problem 23 . Assume that the change in credit terms results in a 2% increase in sales. Recalculate the effect of the changed credit terms.
25. Knob, Inc., is a nationwide distributor of furniture hardware. The company now uses a central billing system for credit sales of $180 million annually. First National, Knob’s principal bank,
27. A parent company settles the collection account balances of its subsidiaries once a week.(That is, each week it transfers any balances in the accounts to a central account.) The cost of a wire
29. A three-month Treasury bill and a six-month bill both sell at a discount of 10%. Which offers the higher annual yield?
34. The IRS prohibits companies from borrowing money to buy tax-exempts and deducting the interest payments on the borrowing from taxable income. Should the IRS prohibit such activity? If it
36. You need to borrow $10 million for 90 days. You have the following alternatives:a. Issue high-grade commercial paper, with a backup line of credit costing .3% a year.b. Borrow from First Cookham
37. Suppose that you are a banker responsible for approving corporate loans. Nine firms are seeking secured loans. They offer the following assets as collateral:a. Firm A, a heating oil distributor,
38. Reliant Umbrellas has been approached by Plumpton Variety Stores of Nevada. Plumpton has expressed interest in an initial purchase of 5,000 umbrellas at $10 each on Reliant’s standard terms of
39. Galenic, Inc., is a wholesaler for a range of pharmaceutical products. Before deducting any losses from bad debts, Galenic operates on a profit margin of 5%. For a long time the firm has employed
40. Axle Chemical Corporation’s treasurer has forecasted a $1 million cash deficit for the next quarter. However, there is only a 50% chance this deficit will actually occur. The treasurer
41. Term loans usually require firms to pay a fluctuating interest rate. For example, the interest rate may be set at “1% above prime.” The prime rate sometimes varies by several percentage
1. The Dun and Bradstreet Web site ( www.dnb.com ) contains a sample comprehensive report on a small business. Would you extend credit to the firm? Why or why not?
2. The three main credit bureaus maintain useful Web sites with examples of their business and consumer reports. Log on to www.equifax.com and look at the sample report on a small business. What
3. Log on to the Federal Reserve site at www.federalreserve.gov and look up current moneymarket interest rates. Suppose your business has $7 million set aside for an expenditure in three months. How
4. The Federal Reserve Bulletin publishes the results of a quarterly survey of bank lending(see www.federalreserve.gov/releases/E2 ). Use the latest survey to describe the pattern of lending by
2. Which of the following motives for mergers make economic sense?a. Merging to achieve economies of scale.b. Merging to reduce risk by diversification.c. Merging to redeploy cash generated by a firm
3. Velcro Saddles is contemplating the acquisition of Pogo Ski Sticks, Inc. The values of the two companies as separate entities are $20 million and $10 million, respectively. Velcro Saddles
5. True or false?a. Sellers almost always gain in mergers.b. Buyers usually gain more than sellers.c. Firms that do unusually well tend to be acquisition targets.d. Merger activity in the United
6. Briefly define the following terms:a. Purchase accountingb. Tender offerc. Poison pilld. Golden parachutee. Synergy INTERMEDIATE
11. Suppose you obtain special information—information unavailable to investors—indicating that Backwoods Chemical’s stock price is 40% undervalued. Is that a reason to launch a takeover bid
12. As treasurer of Leisure Products, Inc., you are investigating the possible acquisition of Plastitoys.You have the following basic data:Leisure Products Plastitoys Earnings per share $ 5.00 $ 1.50
13. The Muck and Slurry merger has fallen through (see Section 31-2 ). But World Enterprises is determined to report earnings per share of $2.67. It therefore acquires the Wheelrim and Axle Company.
3. What are the government’s motives in a privatization?

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