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principles corporate finance

Questions and Answers of Principles Corporate Finance

Common stock valuation. Consider a share of stock that is expected to pay a dividend of $1.50. The firm expects the dividend to increase by 10% during the following year, then by 15% the year after,
Required rate of return. Judy’s Fabric Emporium has a capital gains yield of 6.1%, is expected to pay dividends of $3.15, and has a current market price of $15.51. What is Judy’s required return?
Required rate of return. Suppose a firm has a current price of $43.53 and expects constant growth of 5% from this point forward. If the required rate of return on the equity is 8.75%, what is the
Required rate of return. Henry’s Hammer Shop, Inc., has common stock that is currently selling for $28.06. They just paid a dividend of $1.78 and expect to increase this amount by $0.15 in each of
Multiple growth rates. A share of common stock paid a dividend exactly five years ago of $1.85 and have increased this by $0.18 each year until now.They are now planning on growth of 10% for the next
Multiple growth rates. Greta’s Garden and Variety began issuing common stock 12 years ago. Eight years ago, Greta issued her first dividend at $0.10 per share. For each year since then, she had
Multiple growth rates. Tyler’s Doggie Park, Inc., was founded exactly ten years ago. For the first seven years, they paid no dividend, as they sought to increase their market share first. However,
Common stock valuation. Suppose you have a firm that plans to pay a constant dividend of $0.45 during each of the next six years and then never pay dividends again. At that time, the price will be
Common stock valuation. Hattie’s Hat Emporium just went public at a price of $12.90 per share. They do not plan to pay a dividend for the next three years but then plan to pay a special one-time
Multiple growth rates. Consider Firm ABC. They just paid a dividend of$0.23 per share. They plan to increase this by 12% during each of the next three years. Following that, the firm plans to
Equity portfolios. Suppose you buy 180 shares of Stock A and 100 shares of Stock B. Stock A pays a constant dividend of $0.20 and will do so forever.They have a required rate of return of 7.42%.
Equity portfolios. Suppose you are creating an investment portfolio. You have decided upon two assets:55 Fifty shares of common stock in Firm A. The stock just paid a dividend of $1.25. However, they
Equity portfolios. Your best friend has an equity portfolio made up of three different common stocks: A, B, and C. The details are as follows:55 300 shares of Stock A, which pays a constant dividend
Portfolio required return. Suppose you have a portfolio made up of 55%common stock A and 45% preferred stock B. The common stock is expected to pay a dividend of $4.54 and is currently selling for
Risk and return What is the theoretical relationship between risk and return?
Risk and return Your best friend just said that she took a large risk last year and lost money. She is angry at you because she says you told her that higher risk equaled higher return. What is your
Returns Define both dollar returns and percentage returns. In what situations would you prefer one over the other?
Returns What are the two components of returns? Describe how each relates to the value of the asset. Also describe the two components from both the investor and firm perspective.
Returns Bob just calculated a return of 3.86% last year on Asset A. However, Asset A’s stock price decreased by $3 last year. So, what must have happened?
Returns Describe the differences between arithmetic and geometric returns. In what situation would you prefer to calculate one over the other?
Risk What is the difficulty in calculating risk? Describe the process through which one estimates the risk of an asset.
Confidence intervals What purpose does the confidence interval serve? How does it help extend the application of risk and reward?
Assets and risk You want a safe portfolio. Given that, should you invest primarily in equity or debt? Why? What makes the difference in relation to risk levels?
Assets and risk Are small assets riskier or safer than large, all else equal? Why?
Assets and risk Debt can be issued by corporations or governments. Which is riskier and why?
Expected returns What exactly is meant by expected return? What are the components to the expected return from a data-driven perspective and how are they used in the calculation?
Portfolios What is a portfolio? What are portfolio weights?
Portfolio risk What makes portfolio risk difficult to calculate? Why is it important to consider all correlation between pairs of assets?
Correlation and diversification You just started your retirement portfolio and went to your dad for advice. He said to simply, “diversify, diversify, diversify.”What did he mean by that? Why
Unexpected risk What is the difference between systematic and unsystematic risk?
Diversification Your finance professor just stated that if you diversify correctly, you can eliminate, over time, losses from your investment mistakes. Is that correct?What are the conditions for
Beta You have three assets, A, B, and C. The beta of Asset A is 1.35, the beta of Asset B is −.13, and the beta of Asset C is .77. Describe what should happen to each if the market goes up by 2%.
Security market line What is the security market line? What is the slope? What is the y-intercept? Answer both in mathematical and definitional terms.
Cost of equity How does the CAPM help in estimating the cost of equity?Discuss the implications of the answer for both the firm and the investor.
Fama-French Model What is the difference between CAPM and the Fama-French model? What is the same?
Factors Describe what is meant by a “factor” as used in return analysis? Name some popular factors that have historically been identified and used for portfolio strategy?
Dollar return Suppose you bought 100 shares of Stock ABC at $105.65.Today, they are selling for $102.31. You received dividends of $.26 per quarter for each of the five years you have owned the
Holding period return Suppose you bought 20 shares of Stock XYZ ten years ago for $5.31. For the first five years, Stock XYZ did not pay any dividends. For the remaining five years, they paid a
Bond dollar return You just sold 300 bonds that pay an annual coupon of$76. When you bought them, exactly three years ago, they were selling at$956.28. Today they are selling at $854.24. How is your
Dollar return Exactly three and a half years ago, you began your portfolio using $10,000 given to you by your grandfather. You bought 40 shares of Stock A, which was selling at $83.00. You also
Holding period return If the HPR on a stock over an investment period is 18.26% and the beginning price is $11.50, what is the ending price? Assume that $2.10 in dividends was paid throughout the
Holding period return Suppose you entered into an investment eight years ago.You just sold your entire position of 8,000 shares and have calculated you received a total dollar return of $13,590. You
Holding period returns Four years ago, you bought 100 shares of Stock A at$23.99 per share and 200 shares of Stock B at $12.90 per share. During the first year, Stock A paid a dividend of $.85 per
Geometric returns Suppose a company has had returns over the past four years of 6%, −8%, 7.5%, and −2.5%, respectively. What is the geometric average return for this stock?
Geometric cumulative returns Over the past four years, Stock CCC had returns of 5.04%, 16.14%, −1.85%, and 5.78%. If you invested $1,000 at the beginning of those five years and all returns can be
Historical standard deviation The return on Stock A has been 3.45%,−5.33%, −6.43%, and 2.84% for the last four years, respectively. Given this, what is the historical standard deviation?
Confidence intervals Suppose a stock had returns of 10%, −1%, 8%, −3%, and 11% over the past five years. What is the 95% confidence interval?
Confidence intervals Suppose you have managed a mutual fund for the last five years, with returns of 15.4%, 13.5%, 18.4%, 9.87%, and 10.32% in each of them. There is approximately a 2.5% chance that
Confidence intervals Suppose you have average returns over the last 25 years of 15.65%, while the variance of those returns is 17.98%. Given this, what is the probability your return next year will
Expected returns Over the past 50 years, Stock AAA has an average return of 6.4% during normal economies. The return is half this during bad years.Contrarily, the return is double this during good
Expected returns Over the past 25 years, the average return for Stock ABC has been 12.43% per year. However, during booming economies, this return is 5% higher. On the other hand, during recessionary
Portfolio returns Suppose you have an expected return on the portfolio of 15.6%. You are invested in only two stocks, A and B. The expected return on A is 18.55%, and the expected return on B is
Portfolio risk Your portfolio is made up of 75% Stock A and 25% Stock B. Stock A has a variance of 31.36%, while Stock B has a standard deviation of 6.25%. The covariance between them is 6.8%. What
Portfolio risk Consider a two-asset portfolio. Stock A has a standard deviation of 15%, and Stock B has a standard deviation of 25%. You own 14,000 shares of Stock A, which is currently selling at
Portfolio risk Consider the following historical returns for stocks R, S, and T.If you have weights of 45% R, 25% S, and 20% T, what is your portfolio standard deviation? Year Stock R Stock S Stock T
Beta A stock has a beta of 1.43. If the current stock price is $18.02, what would you expect the price to be if the market goes up by 1.4%?
Beta Suppose Firm VIP has a covariance of 84.87% with the market. The standard deviation of the market is 22.90% and the standard deviation of Firm VIP is 16.89%. What is the beta of Firm VIP?
Portfolio beta Suppose you want a portfolio such that when the market goes up by 2%, your portfolio goes up by 1.70%. In addition, you only have two assets in your portfolio. Asset A has a beta of
Portfolio beta Suppose you have a portfolio made up of 36.8% Stock A, 25% Stock B, and 38.2% in a risk-free asset. The beta of Stock A is .60, while the beta of Stock B is 1.19. If the market goes
Portfolio beta Suppose that over a given month, the market has increased from an index value of 887.76 to 1,023.32. During the same time period, your portfolio has increased from $13,400 to $17,211.
Capital asset pricing model Consider Stock X, which is 50% riskier than the market. If the expected return on the market is 8.9% and the current riskfree rate is 3.2%, what is the expected return on
Capital asset pricing model Portfolio ABC has an expected return of 15%and the market risk premium is 9%. The risk-free rate is 2%. Given this, what is the implied beta according to CAPM?
Holding period return Exactly six years ago, you started your own investment portfolio. To do so, you bought 1,000 shares of common stock A, each selling at $12.97 per share. Common stock A paid a
Portfolio beta You want to create a portfolio that is exactly 50% as risky as the market. You want to create this portfolio from three assets: Stock A, Stock B, and a risk-free asset. Historical
Portfolio returns You have had the following portfolio returns over the past ten years. Also included are the market returns for the same period of time.You may assume that a market return in excess
Portfolio beta Consider the following historical returns for Stocks A and B, along with the returns for the market and the risk-free asset at the end of the last four years.You have a total of
Fama-French Model You have run a portfolio for the past ten years, to the following returns. In addition, you have the Fama-French factors for that period of time.(a) You assume the expected return
Cost of capital. What is meant by the cost of capital? How does the concept apply to the financial operations of a firm, and why is it so important?
Required returns. Discuss the relationship between costs of capital and required returns. Who cares about which and how do they relate to each other, both qualitatively and quantitatively?
Equity. Your boss comes to you and says “why don’t we just use all our retained earnings to fund the project. That’s the company’s money, not the shareholders, so it won’t cost us
Growth rates. Why is estimating the growth rate of a firm so important?Discuss from both the shareholder and firm perspectives.
Growth rates. Compare and contrast at least three different types of growth rate estimates.
Cost of equity. What are the strengths and weaknesses of using both the DGM and CAPM methods of estimating the cost of equity?
Debt sources. List at least two sources of debt capital. What are the characteristics of each?
WACC. Describe in a sentence what the WACC tells the firm.
WACC. Discuss both the qualitative and quantitative implications and design of WACC.
Cost of debt. How do taxes influence the cost of debt? Why? Can you create a personal financial analogy to extend the answer?
Capital structure theories. Briefly describe the primary findings of the capital structure theories discussed in the text. How do we incorporate those findings into capital structure policies?
Financial distress. Bob from accounting just barged into your office and screams “We’re about to go bankrupt! Do something!” Why is Bob so upset?Why is financial distress such a concern for a
Source of funds. Evaluate the statement “the cost of funds depends upon the use of the funds.” What does that mean? Assume you are talking to your supervisor in relation to a project you are
Cost of equity. Kelly’s Tiki Hut has experienced growth of 11% per year over the past 15 years and expects this to continue indefinitely. Three years ago, they began paying dividends. The first
Cost of equity. Suppose ABC Company has stock currently selling at$21.00 per share that just paid dividends of $1.75. They have a required rate of return of 12%. We have the following data for their
Cost of equity. You have just taken a position as chief financial officer of a large, multinational firm. Your first task is to find an appropriate cost of capital to apply to capital budgeting.
Cost of equity. Harry’s Toupee Shop, Inc., has publicly stated they are going to pay dividends next year of $1.24 and then increase this amount by 4% for the following five years. Following that,
Cost of debt. Suppose Bob’s Golf Cart Shop has 4,000 30-year bonds outstanding, each currently selling at $897.64. The bonds have 18 years left until maturity and have a coupon rate of 7.5%. What
Cost of debt. A firm has two types of debt in their capital structure. They have 200 coupon bonds selling at $986.68 each. They also have $200,000 worth of bank debt, which has an interest rate of
Taxes and costs. You need $530,000 and have decided to get it either from bank debt or from issuing equity. The beta on your firm is 0.35, the riskfree rate is 1.75%, and the market risk premium is
Cost of preferred stock. Your firm has 250,000 shares of $50 preferred stock currently selling at $23.56 per share. If these stocks pay a 3.5% dividend, what is the cost of these preferred shares?
Cost of zero-coupon bonds Consider a zero-coupon bond that has a face value of $100 and 13 years left until maturity. If the current price is $54.86, what is the current YTM of this bond?
Capital structure weights. Firm X has a WACC of 9.43%. They only have one type of debt and one type of equity. The cost of their debt is 8.4% and the cost of equity is 11.3%. What is the weight of
Capital structure weights. If the debt-to-equity ratio for a firm is 0.38, what is the weight of debt in the firm’s capital structure?
Capital structure weights. Your firm has an odd capital structure made up of only coupon bonds and preferred stock. The coupon bonds have a YTM of 5.61%. The preferred stock pays a dividend of $1.12
Weighted average cost of capital. Your firm has two types of bonds. First, there are 3,000 bonds outstanding with a 7% coupon rate and a yield to maturity of 6.5%. These bonds are selling at
Weighted average cost of capital. Suppose your firm has five sources of funding. They are as follows:55 400,000 shares of stock currently selling at $12.33 per share. The firm has experienced an
Optimal capital structure. Suppose a firm has four pieces of capital structure.They are as follows:55 Common stock that has a beta of 1.21. In addition, the market risk premium is 9.1% and the
Optimal capital structure. You are in charge of the finance department at Johnny’s Kawasaki, Inc. The firm is considering expanding to Europe and will build a plant in London. The plant will cost
Optimal capital structure. Bobby’s Beer Barn just paid a dividend of $1.06 and has seen their stock price rise to $27.48. However, they are attempting to purchase a new plant that needs capital of
Capital budgeting and capital structure. Discuss the relationship between the capital budgeting and capital structure decisions. Are they made independently or simultaneously? Why? How?
Payback period. What are the strengths and weaknesses of the payback period method of capital budgeting?
Discounted payback period. What differs between the discounted payback period and just the original? Is this difference a big deal?

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