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principles corporate finance

Questions and Answers of Principles Corporate Finance

5. List the disadvantages of traditional U.S. conglomerates.
7. What is the difference between Chapter 7 and Chapter 11 bankruptcies?
9. Explain why equity can sometimes have a positive value even when companies file for bankruptcy.INTERMEDIATE
11. For what kinds of firm would an LBO or MBO transaction not be productive?
14. Read Barbarians at the Gate (Further Reading). What agency costs can you identify? ( Hint:See Chapter 12.) Do you think the LBO was well-designed to reduce these costs?
2. What is a keiretsu? Give a brief description.
5. What is meant by the German system of codetermination?
6. What is the most common form of ownership of corporations worldwide?
9. What is tunneling? Why does the threat of tunneling impede the development of financial markets?INTERMEDIATE
12. Why is transparency important in a market-based financial system? Why is it less important in a bank-based system?
13. What is meant by dual-class equity? Do you think it should be allowed or outlawed?
14. What kind of industries do you think should thrive in a market-based financial system? In a bank-based system?
15. Why are pyramids common in many countries but not in the United States or United Kingdom?
16. What are some of the advantages and disadvantages of Japanese keiretsus?
5. The following table tracks the main components of working capital over the life of a fouryear project.2010 2011 2012 2013 2014 Accounts receivable 0 150,000 225,000 190,000 0 Inventory 75,000
8. Machines A and B are mutually exclusive and are expected to produce the following real cash flows:Cash Flows ($ thousands)Machine C 0 C 1 C 2 C 3 A 100 110 121 B 120 110 121 133 The real
9. Machine C was purchased five years ago for $200,000 and produces an annual real cash flow of $80,000. It has no salvage value but is expected to last another five years. The company can replace
10. Restate the net cash flows in Table 6.6 in real terms. Discount the restated cash flows at a real discount rate. Assume a 20% nominal rate and 10% expected inflation. NPV should be unchanged at
14. Ms. T. Potts, the treasurer of Ideal China, has a problem. The company has just ordered a new kiln for $400,000. Of this sum, $50,000 is described by the supplier as an installation cost. Ms.
15. After spending $3 million on research, Better Mousetraps has developed a new trap. The project requires an initial investment in plant and equipment of $6 million. This investment will be
16. A project requires an initial investment of $100,000 and is expected to produce a cash inflow before tax of $26,000 per year for five years. Company A has substantial acc umulated tax losses and
17. Go to the “live” Excel spreadsheet versions of Tables 6.1 , 6.5 , and 6.6 at www.mhhe.com/bma and answer the following questions.a. How does the guano project’s NPV change if IM&C is forced
18. A widget manufacturer currently produces 200,000 units a year. It buys widget lids from an outside supplier at a price of $2 a lid. The plant manager believes that it would be cheaper to make
19. Reliable Electric is considering a proposal to manufacture a new type of industrial electric motor which would replace most of its existing product line. A research breakthrough has given
20. Marsha Jones has bought a used Mercedes horse transporter for her Connecticut estate. It cost $35,000. The object is to save on horse transporter rentals.Marsha had been renting a transporter
21. United Pigpen is considering a proposal to manufacture high-protein hog feed. The project would make use of an existing warehouse, which is currently rented out to a neighboring firm. The next
24. As a result of improvements in product engineering, United Automation is able to sell one of its two milling machines. Both machines perform the same function but differ in age.The newer machine
26. Hayden Inc. has a number of copiers that were bought four years ago for $20,000. Currently maintenance costs $2,000 a year, but the maintenance agreement expires at the end of two years and
27. Return to the start of Section 6-4, where we calculated the equivalent annual cost of producing reformulated gasoline in California. Capital investment was $400 million. Suppose this amount can
28. The Borstal Company has to choose between two machines that do the same job but have different lives. The two machines have the following costs:Year Machine A Machine B 0 $40,000 $50,000 1 10,000
31. One measure of the effective tax rate is the difference between the IRRs of pretax and after-tax cash flows, divided by the pretax IRR. Consider, for example, an investment I generating a
32. We warned that equivalent annual costs should be calculated in real terms. We did not fully explain why. This problem will show you.Look back to the cash flows for machines A and B (in
1. A game of chance offers the following odds and payoffs. Each play of the game costs$100, so the net profit per play is the payoff less $100.Probability Payoff Net Profit .10 $500 $400 .50 100 0
2. The following table shows the nominal returns on the U.S. stocks and the rate of inflation.a. What was the standard deviation of the market returns?b. Calculate the average real return.Year
3. During the boom years of 2003–2007, ace mutual fund manager Diana Sauros produced the following percentage rates of return. Rates of return on the market are given for comparison.2003 2004 2005
5. In which of the following situations would you get the largest reduction in risk by spreading your investment across two stocks?a. The two shares are perfectly correlated.b. There is no
9. What is the beta of each of the stocks shown in Table 7.8 ?◗ TABLE 7.8 See Problem 9.Stock Return if Market Return Is:Stock ⫺10% ⫹10%A 0 ⫹20 B ⫺20 ⫹20 C ⫺30 0 D ⫹15 ⫹15 E ⫹10
10. Here are inflation rates and U.S. stock market and Treasury bill returns between 1929 and 1933:Year Inflation Stock Market Return T-Bill Return 1929 ⫺.2 ⫺14.5 4.8 1930 ⫺6.0 ⫺28.3 2.4 1931
13. Lonesome Gulch Mines has a standard deviation of 42% per year and a beta of ⫹ .10.Amalgamated Copper has a standard deviation of 31% a year and a beta of ⫹ .66. Explain why Lonesome Gulch is
15.a. How many variance terms and how many covariance terms do you need to calculate the risk of a 100-share portfolio?b. Suppose all stocks had a standard deviation of 30% and a correlation with
16. Suppose that the standard deviation of returns from a typical share is about .40 (or 40%) a year. The correlation between the returns of each pair of shares is about .3.a. Calculate the variance
17. Table 7.9 shows standard deviations and correlation coefficients for eight stocks from different countries. Calculate the variance of a portfolio with equal investments in each stock.
18. Your eccentric Aunt Claudia has left you $50,000 in Canadian Pacific shares plus $50,000 cash. Unfortunately her will requires that the Canadian Pacific stock not be sold for one year and the
19. There are few, if any, real companies with negative betas. But suppose you found one with␤ ⫽ ⫺ .25.a. How would you expect this stock’s rate of return to change if the overall market rose
20. You can form a portfolio of two assets, A and B, whose returns have the following characteristics:Stock Expected Return Standard Deviation Correlation A 10% 20%.5 B 15 40 If you demand an
21. Here are some historical data on the risk characteristics of Dell and McDonald’s:Dell McDonald’s␤ (beta) 1.41 .77 Yearly standard deviation of return (%) 30.9 17.2 Assume the standard
22. Suppose that Treasury bills offer a return of about 6% and the expected market risk premium is 8.5%. The standard deviation of Treasury-bill returns is zero and the standard deviation of market
23. Calculate the beta of each of the stocks in Table 7.9 relative to a portfolio with equal investments in each stock.
3. A large mutual fund group such as Fidelity offers a variety of funds. They include sector funds that specialize in particular industries and index funds that simply invest in the market index. Log
1. Here are returns and standard deviations for four investments.Return Standard Deviation Treasury bills 6 % 0%Stock P 10 14 Stock Q 14.5 28 Stock R 21 26 Calculate the standard deviations of the
2. For each of the following pairs of investments, state which would always be preferred by a rational investor (assuming that these are the only investments available to the investor):a. Portfolio A
5.a. Plot the following risky portfolios on a graph:Portfolio A B C D E F G H Expected return (r), % 10 12.5 15 16 17 18 18 20 Standard deviation ( ), % 23 21 25 29 29 32 35 45b. Five of these
9. True or false? Explain or qualify as necessary.a. Investors demand higher expected rates of return on stocks with more variable rates of return.b. The CAPM predicts that a security with a beta of
10. Look back at the calculation for Campbell Soup and Boeing in Section 8.1 . Recalculate the expected portfolio return and standard deviation for different values of x 1 and x 2 , assuming the
11. Mark Harrywitz proposes to invest in two shares, X and Y. He expects a return of 12%from X and 8% from Y. The standard deviation of returns is 8% for X and 5% for Y. The correlation coefficient
12. Ebenezer Scrooge has invested 60% of his money in share A and the remainder in share B.He assesses their prospects as follows:A B Expected return (%) 15 20 Standard deviation (%) 20 22
13. Look back at Problem 3 in Chapter 7. The risk-free interest rate in each of these years was as follows:2003 2004 2005 2006 2007 Interest rate% 1.01 1.37 3.15 4.73 4.36a. Calculate the average
14. Look back at Table 7.5 on page 174.a. What is the beta of a portfolio that has 40% invested in Disney and 60% in Exxon Mobil?b. Would you invest in this portfolio if you had no superior
16. Percival Hygiene has $10 million invested in long-term corporate bonds. This bond portfolio’s expected annual rate of return is 9%, and the annual standard deviation is 10%.Amanda Reckonwith,
17. Epsilon Corp. is evaluating an expansion of its business. The cash-flow forecasts for the project are as follows:Years Cash Flow ($ millions)0 100 1–10 15 The firm’s existing assets have a
18. Some true or false questions about the APT:a. The APT factors cannot reflect diversifiable risks.b. The market rate of return cannot be an APT factor.c. There is no theory that specifically
19. Consider the following simplified APT model:Factor Expected Risk Premium Market 6.4%Interest rate .6 Yield spread 5.1 Calculate the expected return for the following stocks. Assume r f 5%.Factor
20. Look again at Problem 19. Consider a portfolio with equal investments in stocks P, P 2 , and P 3 .a. What are the factor risk exposures for the portfolio?b. What is the portfolio’s expected
21. The following table shows the sensitivity of four stocks to the three Fama–French factors.Estimate the expected return on each stock assuming that the interest rate is .2%, the expected risk
22. In footnote 4 we noted that the minimum-risk portfolio contained an investment of 73.1%in Campbell Soup and 26.9% in Boeing. Prove it. ( Hint: You need a little calculus to do so.)
23. Look again at the set of the three efficient portfolios that we calculated in Section 8.1 .a. If the interest rate is 10%, which of the four efficient portfolios should you hold?b. What is the
24. The following question illustrates the APT. Imagine that there are only two pervasive macroeconomic factors. Investments X, Y, and Z have the following sensitivities to these two
1.a. Look at the efficient portfolios constructed from the 10 stocks in Table 8.1 . How does the possibility of short sales improve the choices open to the investor?b. Now download up to 10 years of
2. Find a low-risk stock—Exxon Mobil or Kellogg would be a good candidate. Use monthly returns for the most recent three years to confirm that the beta is less than 1.0. Now estimate the annual
3. Recalculate the betas for the stocks in Table 8.2 using the latest 60 monthly returns.Recalculate expected rates of return from the CAPM formula, using a current risk-free rate and a market risk
8. Which of these projects is likely to have the higher asset beta, other things equal? Why?a. The sales force for project A is paid a fixed annual salary. Project B’s sales force is paid by
12. Nero Violins has the following capital structure:Security Beta Total Market Value($ millions)Debt 0 $100 Preferred stock .20 40 Common stock 1.20 299a. What is the firm’s asset beta? ( Hint:
13. The following table shows estimates of the risk of two well-known Canadian stocks:Standard Deviation, % R 2 Beta Standard Error of Beta Toronto Dominion Bank 25 .25 .82 .18 Canadian Pacific 28
19. Mom and Pop Groceries has just dispatched a year’s supply of groceries to the government of the Central Antarctic Republic. Payment of $250,000 will be made one year hence after the shipment
21. A project has the following forecasted cash flows:Cash Flows, $ Thousands C0 C 1 C 2 C 3⫺100 ⫹40 ⫹60 ⫹50 The estimated project beta is 1.5. The market return r m is 16%, and the risk-free
24. An oil company executive is considering investing $10 million in one or both of two wells:well 1 is expected to produce oil worth $3 million a year for 10 years; well 2 is expected to produce $2
1. Look at the companies listed in Table 8.2. Calculate monthly rates of return for two successive five-year periods. Calculate betas for each subperiod using the Excel SLOPE function. How stable was
2. Identify a sample of food companies. For example, you could try Campbell Soup (CPB), General Mills (GIS), Kellogg (K), Kraft Foods (KFT), and Sara Lee (SLE).a. Estimate beta and R 2 for each
5. Suppose a manager has already estimated a project’s cash flows, calculated its NPV, and done a sensitivity analysis like the one shown in Table 10.2 . List the additional steps required to carry
9. Look back to the cash flows for projects F and G in Section 5-3. The cost of capital was assumed to be 10%. Assume that the forecasted cash flows for projects of this type are overstated by 8% on
10. What is the NPV of the electric scooter project under the following scenario?Market size 1.1 million Market share .1 Unit price ¥400,000 Unit variable cost ¥360,000 Fixed cost ¥2 billion
11. Otobai’s staff (see Section 10-2) has come up with the following revised estimates for the electric scooter project:Pessimistic Expected Optimistic Market size .8 million 1.0 million 1.2
12. Otobai is considering still another production method for its electric scooter (see Section 10-2). It would require an additional investment of ¥15 billion but would reduce variable costs by
13. The Rustic Welt Company is proposing to replace its old welt-making machinery with more modern equipment. The new equipment costs $9 million (the existing equipment has zero salvage value). The
15. Operating leverage is often measured as the percentage increase in pretax profits after depreciation for a 1% increase in sales.a. Calculate the operating leverage for the electric scooter
21. Magna Charter is a new corporation formed by Agnes Magna to provide an executive flying service for the southeastern United States. The founder thinks there will be a ready demand from businesses
4. On the London Metals Exchange the price for copper to be delivered in one year is $3,450 a ton. ( Note: Payment is made when the copper is delivered.) The risk-free interest rate is.5% and the
6. Suppose that you are considering investing in an asset for which there is a reasonably good secondary market. Specifically, your company is Delta Airlines, and the asset is a Boeing 757—a widely
12. Go to the “live” Excel spreadsheets versions of Tables 11.1–11.3 at www.mhhe.com/bma.Reevaluate the NPV of the proposed polyzone project under each of the following assumptions.What’s the
13. Photographic laboratories recover and recycle the silver used in photographic film. Stikine River Photo is considering purchase of improved equipment for their laboratory at Telegraph Creek. Here
15. You are asked to value a large building in northern New Jersey. The valuation is needed for a bankruptcy settlement. Here are the facts:• The settlement requires that the building’s value
17. The world airline system is composed of the routes X and Y, each of which requires 10 aircraft. These routes can be serviced by three types of aircraft—A, B, and C. There are 5 type A aircraft
18. Taxes are a cost, and, therefore, changes in tax rates can affect consumer prices, project lives, and the value of existing firms. The following problem illustrates this. It also illustrates that
10. Who monitors the top management of public U.S. corporations? (We have mentioned four types of monitoring in this chapter.)
12. Here are a few questions about compensation schemes that tie top management’s compensation to the rate of return earned on the company’s common stock.a. Today’s stock price depends on
13. You chair the compensation committee of the board of directors of Androscoggin Copper.A consultant suggests two stock-option packages for the CEO:a. A conventional stock-option plan, with the
14. Table 12.5 shows a condensed income statement and balance sheet for Androscoggin Copper’s Rumford smelting plant.a. Calculate the plant’s EVA. Assume the cost of capital is 9%.b. As Table
15. Herbal Resources is a small but profitable producer of dietary supplements for pets. This is not a high-tech business, but Herbal’s earnings have averaged around $1.2 million after tax,◗
17. Consider the following project:Period 0 1 2 3 Net cash flow ⫺100 0 78.55 78.55 The internal rate of return is 20%. The NPV, assuming a 20% opportunity cost of capital, is exactly zero.
18. Calculate the year-by-year book and economic profitability for investment in polyzone production, as described in Chapter 11. Use the cash flows and competitive spreads shown in Table 11.2, and

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