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principles corporate finance

Questions and Answers of Principles Corporate Finance

STRIPS Consider an issuance of government bonds that have 20 years until maturity. The bond pays semiannual coupons based upon a CR of 5.2 % and face value of $1,000. Suppose the bonds get
Bond prices You buy 30 STRIPs that have 12 years left until maturity and a required return of 7.43 %. In addition, you buy twelve 5 % coupon bonds that have 10 years left until maturity and yield 6.3
Callable bonds Consider a bond that is callable at 102.If the current YTC is 7.4 %, the CR is 6.9 %, and the bond has 14 years left until earliest call. If you believe the bond is going to be called
Callable bond yields Consider Bond XYZ, which is currently priced at$986.76 and is callable in 2 years at 102.It pays a coupon rate of 7.54 % in semiannual coupons. It will expire in 4 years and has
Bond portfolio yield Suppose you have just created a bond portfolio made up of 3 bond holdings. You bought 100 corporate bonds that have coupon rates of 7.4 %, compounded semiannually, with 14 years
Gordon Growth Model A firm just paid a dividend of $1.45. If the growth rate is a constant 5.42 % and the required return is 6.4 %, what is the current price of a share of stock, according to the GGM?
Bond portfolios Exactly 3 years ago, you started a portfolio. The portfolio was made up of 12 coupon bonds and 14 zero-coupon bonds:• The coupon bonds have a coupon rate of 6.69 %, paid
Equity Define to someone who has never heard the notion exactly what equity is. Do so from both the firm and investor perspective.
Public equity What distinguishes public equity from private equity? Why would a firm want either, or both?
Gordon Growth Model Suppose Scotty is expected to pay a dividend of $1.75 next year. If the required return is 5.47 % and the expected growth rate is 3.64 %, what is the expected price at time 6?
Common stock Your grandpa doesn’t understand why anyone would want to invest in the stock market instead of just putting their money in the bank.Explain to him the benefits of investing in common
Gordon Growth Model The current price of share of common stock is $25.80.If the company expects perpetual growth of 3.6 % and has a required return of 8 %, what dividend could be expected at time 4?
Equity valuation Why is equity valuation more difficult than bond valuation?Create an analogy to help explain to a beginner.
Common stock valuation Suppose a firm is expected to pay a dividend of$1.25 in each of the next 4 years and then never pay a dividend again. If the firms required return is 5.4 %, at what price would
Dividends What is the difference between current dividends and expected dividends? When would you use each, and why?
Common stock valuation Ned’s Aquarium Hut, Inc., plans to pay a constant dividend of $.40 in each of the next 4 years. At that point, he plans to increase the dividend at a constant rate of 6 %
Preferred stock Your investing buddy says to you, “Why not buy preferred stock? It says right in the name that we should prefer them over common stock.” How do you respond?
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?
Gordon Growth Model What is the mathematical basis underlying the dividend growth model? If the required return increases, does this increase or decrease the stock price?
Required rate of return Suppose a firm has a current price of $43.53 and expect growth of 4 %. The firm expects constant growth of 5 % from this point forward. If the required rate of return on the
Gordon Growth Model Show three ways the Gordon Growth Model can be used, from either firm’s or investor’s perspective.
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 $.15 in each of
Required return What are the two components to the required return on common stock? What do they mean for the firm? What about for the investor?
Multiple growth rates A share of common stock paid a dividend exactly 5 years ago of $1.85 and have increased this by $.18 each year until now.They are now planning on growth of 10 % for the next 3
Required return What is the relationship between required returns and growth rates in the Gordon Growth Model?
Multiple growth rates Greta’s Garden and Variety began issuing common stock 12 years ago. Eight years ago, Greta issued her first dividend at $.10 per share. For each year since then, she had
Dividends Detail the four dates of concern dealing with dividend payments.From an investor’s perspective, when would you have to buy to receive the dividend?
Multiple growth rates Tyler’s Doggie Park, Inc., was founded exactly 10 years ago. For the first 7 years, they paid no dividend, as they sought to increase their market share first. However, at
Dividends CEO Davidson knows the firm is falling into a financial black hole but refuses to reduce the dividend. Why is he being so stubborn? Is there any reason why he is correct in his stubbornness?
Common stock valuation Suppose you have a firm that plans to pay a constant dividend of $.45 during each of the next 6 years and then never pay dividends again. At that time, the price will be $3.64.
Stock exchanges Compare and contrast the NYSE and Nasdaq. How do they work, and what role do they play in the financial landscape?
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 3 years but then plan to pay a special one-time dividend
Stock exchanges Your best friend, Betty, just burst into your apartment with the following proclamation. “I just saw the movie ‘Wall Street,’ and I was so blown away by all the action on the
Multiple growth rates Consider Firm ABC. They just paid a dividend of $.23 per share. They plan to increase this by 12 % during each of the next 3 years. In addition, during the third time period,
Equity portfolios Suppose you buy 180 shares of Stock A and 100 shares of Stock B. Stock A pays a constant dividend of $.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:(a) Fifty shares of common stock in Firm A. The stock just paid a dividend of$1.25. However, they
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?
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 5 years you have owned the stock.
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
Holding period return Suppose you bought 20 shares of Stock XYZ 10 years ago for $5.31. For the first 5 years, Stock XYZ did not pay any dividends. For the remaining 5 years, they paid a dividend of
Returns Define both dollar returns and percentage returns. In what situations would you prefer one over the other?
Bond dollar return You just sold 300 bonds that pay an annual coupon of $76.When you bought them, exactly 3 years ago, they were selling at $956.28.Today they are selling at $854.24. How is your
Physical asset percentage return Suppose you paid $30,000 for a work truck and have used it for 15 years. During each of those 15 years, the truck earned you a profit of $2,000. Today you are selling
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?
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
Risk What is the difficulty in calculating risk? Describe the process through which one estimates the risk of an asset.
Returns Describe the differences between arithmetic and geometric returns. In what situation would you prefer to calculate one over the other?
Holding period return If the HPR on a stock throughout time t is 18.26 % and the beginning price is $11.50, what is the ending price? Assume that $2.10 in dividends was paid throughout time t.
Holding period return Suppose you entered into an investment 8 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 sold
Confidence intervals What purpose does the confidence interval serve? How does it help extend the application of risk and reward?
Holding period returns 4 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 share
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?
Geometric returns Suppose a company has had returns over the past 4 years of 6 %, 8 %, 7.5 %, and 2.5 %, respectively. What is the geometric average return for this stock?
Assets and risk Are small assets riskier or safer than large, all else equal?Why?
Geometric cumulative returns Over the past 4 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 4 years and all returns can be
Assets and risk Debt can be issued by corporations or governments. Which is riskier and why?
Historical standard deviation The return on Stock A has been 3.45 %,-5.33 %, 6.43 %, and 2.84 % for the last 4 years, respectively. Given this, what is the historical standard deviation?
Expected returns What exactly is meant by expected return? What are the components to the expected return and how are they used in the calculation?
Confidence intervals Suppose a stock had returns of 10 %, 1 %, 8%, 3 %, and 11 % over the past 5 years. What is the 95 % confidence interval?
Portfolios risk What makes portfolio risk difficult to calculate? Why is it important to consider all correlation between pairs of assets?
Confidence intervals Suppose you have managed a mutual fund for the last 5 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
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
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
Unexpected risk What is the difference between systematic and unsystematic risk?
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 recessionary years. Contrarily, the return is double this
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
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 45 % higher. On the other hand, during
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.
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
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.
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 %.
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 share 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 1
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 2 assets in your portfolio. Asset A has a beta of
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.
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
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 risk-free rate is 3.2 %, what is the expected return
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
Holding period return Exactly 6 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 returns You have had the following portfolio returns over the past 10 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 4 years.You have a total of $80,000
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?
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
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?
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
Equity Your boss comes to you and says “why don’t we just use all our retained earnings for the project. That’s the company’s money, not the shareholders.”What is the fallacy of this
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.
Growth rates Why is estimating the growth rate of a firm so important?Discuss from both the shareholder and firm perspective.
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 5 years. Following that,
Cost of equity What are the strengths and weaknesses of using both the DGM and CAPM methods of estimating the cost of equity?
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
Debt sources List at least three sources of debt capital. What are the characteristics of each?
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 4.5
WACC Describe in a sentence what the WACC tells the firm. Where does it come from?
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 .35, the risk-free rate is 1.75 %, and the market risk premium is

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