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business
principles corporate finance

Questions and Answers of Principles Corporate Finance

Consider a project that requires an initial investment of $100,000 and will produce a single cash flow of $150,000 in five years.a. What is the NPV of this project if the five-year interest rate is
Using the term structure in Problem 29, what is the present value of an investment that pays$100 at the end of each of years 1, 2, and 3? If you wanted to value this investment correctly using the
What is the shape of the yield curve given the term structure in Problem 29? What expectations are investors likely to have about future interest rates?Appendix
Figure 5.4 shows that Microsoft’s five-year borrowing rate is 3.1% and Netflix’s is 5.1%. Which would you prefer: $500 from Microsoft paid today or a promise that the firm will pay you $600 in
Your best taxable investment opportunity has an EAR of 4%. Your best tax-free investment opportunity has an EAR of 3%. If your tax rate is 30%, which opportunity provides the higher after-tax
Your uncle Fred just purchased a new boat. He brags to you about the low 7% interest rate(APR, monthly compounding) he obtained from the dealer. The rate is even lower than the rate he could have
You are enrolling in an MBA program. To pay your tuition, you can either take out a standard student loan (so the interest payments are not tax deductible) with an EAR of 5½% or you can use a
Suppose you have outstanding debt with an 8% interest rate that can be repaid any time, and the interest rate on U.S. Treasuries is only 5%. You plan to repay your debt using any cash that you
Your firm is considering the purchase of a new office phone system. You can either pay $32,000 now, or $1000 per month for 36 months.a. Suppose your firm currently borrows at a rate of 6% per year
After reading the Novy-Marx and Rauh article (see the Common Mistake Box on page 167), you decide to compute the total obligation of the state you live in. After some research you determine that your
A 30-year bond with a face value of $1000 has a coupon rate of 5.5%, with semiannual payments.a. What is the coupon payment for this bond?b. Draw the cash flows for the bond on a timeline.Appendix
Assume that a bond will make payments every six months as shown on the following timeline(using six-month periods):a. What is the maturity of the bond (in years)?b. What is the coupon rate (in
The following table summarizes prices of various default-free, zero-coupon bonds (expressed as a percentage of face value):a. Compute the yield to maturity for each bond.b. Plot the zero-coupon yield
Suppose the current zero-coupon yield curve for risk-free bonds is as follows:a. What is the price per $100 face value of a two-year, zero-coupon, risk-free bond?b. What is the price per $100 face
In the Finance in Times of Disruption box in Section 6.1, www.Bloomberg.com reported that the three-month Treasury bill sold for a price of $100.002556 per $100 face value. What is the yield to
Suppose a 10-year, $1000 bond with an 8% coupon rate and semiannual coupons is trading for a price of $1034.74.a. What is the bond’s yield to maturity (expressed as an APR with semiannual
Suppose a five-year, $1000 bond with annual coupons has a price of $900 and a yield to maturity of 6%. What is the bond’s coupon rate?Appendix
The prices of several bonds with face values of $1000 are summarized in the following table:For each bond, state whether it trades at a discount, at par, or at a premium.Appendix Bond Price A $972.50
Explain why the yield of a bond that trades at a discount exceeds the bond’s coupon rate.Appendix
Suppose a seven-year, $1000 bond with an 8% coupon rate and semiannual coupons is trading with a yield to maturity of 6.75%.a. Is this bond currently trading at a discount, at par, or at a premium?
Suppose you purchase a 10-year bond with 6% annual coupons. You hold the bond for four years, and sell it immediately after receiving the fourth coupon. If the bond’s yield to maturity was 5% when
Consider the following bonds:a. What is the percentage change in the price of each bond if its yield to maturity falls from 6% to 5%?b. Which of the bonds A–D is most sensitive to a 1% drop in
Suppose you purchase a 30-year, zero-coupon bond with a yield to maturity of 6%. You hold the bond for five years before selling it.a. If the bond’s yield to maturity is 6% when you sell it, what
Suppose you purchase a 30-year Treasury bond with a 5% annual coupon, initially trading at par.In 10 years’ time, the bond’s yield to maturity has risen to 7% (EAR).a. If you sell the bond now,
Suppose the current yield on a one-year, zero coupon bond is 3%, while the yield on a five-year, zero coupon bond is 5%. Neither bond has any risk of default. Suppose you plan to invest for one year.
What is the price today of a two-year, default-free security with a face value of $1000 and an annual coupon rate of 6%? Does this bond trade at a discount, at par, or at a premium?assume zero-coupon
What is the price of a five-year, zero-coupon, default-free security with a face value of $1000?assume zero-coupon yields on default-free securities are as summarized in the following table:Appendix
What is the price of a three-year, default-free security with a face value of $1000 and an annual coupon rate of 4%? What is the yield to maturity for this bond?assume zero-coupon yields on
What is the maturity of a default-free security with annual coupon payments and a yield to maturity of 4%? Why?assume zero-coupon yields on default-free securities are as summarized in the following
Consider a four-year, default-free security with annual coupon payments and a face value of$1000 that is issued at par. What is the coupon rate of this bond?assume zero-coupon yields on default-free
Consider a five-year, default-free bond with annual coupons of 5% and a face value of$1000.a. Without doing any calculations, determine whether this bond is trading at a premium or at a discount.
Prices of zero-coupon, default-free securities with face values of $1000 are summarized in the following table:Suppose you observe that a three-year, default-free security with an annual coupon rate
Assume there are four default-free bonds with the following prices and future cash flows:Do these bonds present an arbitrage opportunity? If so, how would you take advantage of this opportunity? If
Suppose you are given the following information about the default-free, coupon- paying yield curve:a. Use arbitrage to determine the yield to maturity of a two-year, zero-coupon bond.b. What is the
Explain why the expected return of a corporate bond does not equal its yield to maturity.Appendix
In the Data Case in Chapter 5, we suggested using the yield on Florida Sate bonds to estimate the State of Florida’s cost of capital. Why might this estimate overstate the actual cost of
Grummon Corporation has issued zero-coupon corporate bonds with a five-year maturity.Investors believe there is a 20% chance that Grummon will default on these bonds. If Grummon does default,
The following table summarizes the yields to maturity on several one-year, zero-coupon securities:a. What is the price (expressed as a percentage of the face value) of a one-year, zero-coupon
HMK Enterprises would like to raise $10 million to invest in capital expenditures. The company plans to issue five-year bonds with a face value of $1000 and a coupon rate of 6.5% (annual payments).
A BBB-rated corporate bond has a yield to maturity of 8.2%. A U.S. Treasury security has a yield to maturity of 6.5%. These yields are quoted as APRs with semiannual compounding.Both bonds pay
What does it mean for a country to “inflate away” its debt? Why might this be costly for investors even if the country does not default?Appendix
Suppose the yield on German government bonds is 1%, while the yield on Spanish government bonds is 6%. Both bonds are denominated in euros. Which country do investors believe is more likely to
Your brother wants to borrow $10,000 from you. He has offered to pay you back $12,000 in a year. If the cost of capital of this investment opportunity is 10%, what is its NPV? Should you undertake
You are considering investing in a start-up company. The founder asked you for $200,000 today and you expect to get $1,000,000 in nine years. Given the riskiness of the investment opportunity, your
You are considering opening a new plant. The plant will cost $100 million up front. After that, it is expected to produce profits of $30 million at the end of every year. The cash flows are expected
Your firm is considering the launch of a new product, the XJ5. The up-front development cost is $10 million, and you expect to earn a cash flow of $3 million per year for the next five years.Plot the
Bill Clinton reportedly was paid $15 million to write his book My Life. Suppose the book took three years to write. In the time he spent writing, Clinton could have been paid to make speeches. Given
FastTrack Bikes, Inc. is thinking of developing a new composite road bike. Development will take six years and the cost is $200,000 per year. Once in production, the bike is expected to make $300,000
OpenSeas, Inc. is evaluating the purchase of a new cruise ship. The ship would cost $500 million, and would operate for 20 years. OpenSeas expects annual cash flows from operating the ship to be $70
You are CEO of Rivet Networks, maker of ultra-high performance network cards for gaming computers, and you are considering whether to launch a new product. The product, the Killer X3000, will cost
You are considering an investment in a clothes distributor. The company needs $100,000 today and expects to repay you $120,000 in a year from now. What is the IRR of this investment opportunity?Given
You have been offered a very long term investment opportunity to increase your money one hundredfold. You can invest $1000 today and expect to receive $100,000 in 40 years. Your cost of capital for
Does the IRR rule agree with the NPV rule in Problem 3? Explain.Appendix
How many IRRs are there in part (a) of Problem 5? Does the IRR rule give the right answer in this case? How many IRRs are there in part (b) of Problem 5? Does the IRR rule work in this case?Appendix
Professor Wendy Smith has been offered the following deal: A law firm would like to retain her for an up-front payment of $50,000. In return, for the next year the firm would have access to 8 hours
Innovation Company is thinking about marketing a new software product. Up-front costs to market and develop the product are $5 million. The product is expected to generate profits of$1 million per
You have 3 projects with the following cash flows:a. For which of these projects is the IRR rule reliable?b. Estimate the IRR for each project (to the nearest 1%).c. What is the NPV of each project
You own a coal mining company and are considering opening a new mine. The mine itself will cost $120 million to open. If this money is spent immediately, the mine will generate $20 million for the
Your firm spends $500,000 per year in regular maintenance of its equipment. Due to the economic downturn, the firm considers forgoing these maintenance expenses for the next three years. If it does
You are considering purchasing a defunct mine in Africa. Your firm has developed a method to extract valuable rare earth minerals from the mining entrails. The cost of the mine together with the
You are a real estate agent thinking of placing a sign advertising your services at a local bus stop. The sign will cost $5000 and will be posted for one year. You expect that it will generate
You are considering making a movie. The movie is expected to cost $10 million up front and take a year to make. After that, it is expected to make $5 million in the first year it is released and$2
You are deciding between two mutually exclusive investment opportunities. Both require the same initial investment of $10 million. Investment A will generate $2 million per year(starting at the end
Use the incremental IRR rule to correctly choose between the investments in Problem 23 when the cost of capital is 7%. At what cost of capital would your decision change?Appendix
You work for an outdoor play structure manufacturing company and are trying to decide between two projects:You can undertake only one project. If your cost of capital is 8%, use the incremental IRR
You are evaluating the following two projects:Use the incremental IRR to determine the range of discount rates for which each project is optimal to undertake. Note that you should also include the
Consider two investment projects, both of which require an up-front investment of $10 million and pay a constant positive amount each year for the next 10 years. Under what conditions can you rank
You are considering a safe investment opportunity that requires a $1000 investment today, and will pay $500 two years from now and another $750 five years from now.a. What is the IRR of this
Facebook is considering two proposals to overhaul its network infrastructure. They have received two bids. The first bid, from Huawei, will require a $20 million up-front investment and will generate
Natasha’s Flowers, a local florist, purchases fresh flowers each day at the local flower market.The buyer has a budget of $1000 per day to spend. Different flowers have different profit margins,
Orchid Biotech Company is evaluating several development projects for experimental drugs.Although the cash flows are difficult to forecast, the company has come up with the following estimates of the
Using the data from Table 12.3, what is the volatility (standard deviation) of a portfolio with equal amounts invested in Apple and Microsoft stock? What is the standard deviation of a portfolio with
Based on historical data, your expected annual return for Target is 6% and for Berkshire Hathaway is 5%. What is the expected return and risk (standard deviation) of your portfolio if you hold only
Suppose the risk-free return is 3% and you measure the market risk premium to be 6%. Apple has a beta of 1.2. According to the CAPM, what is its expected return?
Suppose drug-maker Pfizer (PFE) has a beta of 0.7, whereas the beta of Google (GOOG) is 0.9. If the risk-free interest rate is 3% and the market risk premium is 6%, what is the expected return of
Define correlation. What does the range between +1 and –1 signify?
You buy 200 shares of Tidepool Co. for \($55\) each and 400 shares of Madfish, Inc., for \($25\) each. What are the weights in your portfolio?
Fremont Enterprises has an expected return of 12% and Laurelhurst News has an expected return of 25%. If you put 60% of your portfolio in Laurelhurst and 40% in Fremont, what is the expected return
You have \($85,000\). You put 25% of your money in a stock with an expected return of 18%, \($38,000\) in a stock with an expected return of 25%, and the rest in a stock with an expected return of
Using the spreadsheet from Problem 10 and the fact that Cola Co. and Gas Co. have a correlation of 0.6083, calculate the volatility (standard deviation) of a portfolio that is 55% invested in Cola
Using the data in Table 12.2,a. Compute the annual returns for a portfolio with 25% invested in North Air, 25% invested in West Air, and 50% invested in Texas Oil.b. What is the lowest annual return
Using the data from Table 12.3, what is the volatility of an equally weighted portfolio of Microsoft and Ford stock?
You have a portfolio with a standard deviation of 30% and an expected return of 18%. You are considering adding one of the two stocks in the following table. If after adding the stock you will have
Suppose all possible investment opportunities in the world are limited to the five stocks listed in the following table. What are the market portfolio weights (see MyFinanceLab for the data in Excel
Given $100,000 to invest, construct a value-weighted portfolio of the four stocks listed below (see MyFinanceLab for the data in Excel format). Stock Price/Share ($) Number of Shares Outstanding
You hear on the news that the S&P 500 was down 2% today relative to the risk-free rate (the market’s excess return was –2%). You are thinking about your portfolio and your investments in Zynga
Suppose the risk-free return is 5% and the market portfolio has an expected return of 15% and a standard deviation of 22%. Johnson & Johnson Corporation stock has a beta of 0.98. What is its expected
EJH has a beta of 1.8, CSH has a beta of 0.8, and KMS has a beta of 1.2. If you put 35% of your money in EJH, 25% in CSH, and 40% in KMS, what is the beta of your portfolio?
Suppose Intel stock has a beta of 1.8, whereas Boeing stock has a beta of 1.2. If the risk-free interest rate is 5% and the expected return of the market portfolio is 15%, according to the CAPM,a.
You are thinking of buying a stock priced at \($103\) per share. Assume that the risk-free rate is about 5.5% and the market risk premium is 9%. If you think the stock will rise to \($122\) per share
You are analyzing a stock that has a beta of 2.4. The risk-free rate is 3% and you estimate the market risk premium to be 8%. If you expect the stock to have a return of 15% over the next year,
You have risen through the ranks of a coffee company, from the lowly green-apron barista to the coveted black apron, and all the way to CFO. A quick Internet check shows you that your company’s
At the beginning of 2013, Apple’s beta was 1.2 and the risk-free rate was about 3%. Apple’s price was \($75\). Apple’s price at the end of 2013 was \($80\). If you estimate the market risk
When evaluating a project in a new line of business, which assumptions for the WACC method are most likely to be violated?
Assuming that you can borrow all the funding to finance your expansion project at 8%, does it mean that 8% would be your cost of capital for the project? What is the cost of capital measured by WACC?
Book Co. has 2 million shares of common equity with a par (book) value of \($5\), retained earnings of \($30\) million, and its shares have a market value of \($25\) per share. It also has debt with
Avicorp has a \($15\) million debt issue outstanding, with an 8% coupon rate. The debt has semiannual coupons, the next coupon is due in six months, and the debt matures in eight years. It is
Laurel, Inc., has debt outstanding with a coupon rate of 10% and a yield to maturity of 8%. Its tax rate is 40%. What is Laurel’s effective (after-tax) cost of debt?
Dewyco has preferred stock trading at \($80\) per share. The next preferred dividend of \($5\) is due in one year. What is Dewyco’s cost of capital for preferred stock?
Steady Company’s stock has a beta of 1.80. If the risk-free rate is 5% and the market risk premium is 9%, what is an estimate of Steady Company’s cost of equity?

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