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business
principles managerial finance

Questions and Answers of Principles Managerial Finance

12–15 What important factors in addition to quantitative factors should a firm consider when it is making a capital structure decision?
12–14 Why do maximizing EPS and maximizing value not necessarily lead to the same conclusion about the optimal capital structure?
12–13 Explain the EBIT–EPS approach to capital structure. Include in your explanation a graph indicating the financial breakeven point; label the axes. Is this approach consistent with
12–12 How do the cost of debt, the cost of equity, and the weighted average cost of capital (WACC) behave as the firm’s financial leverage increases from zero? Where is the optimal capital
12–11 How does asymmetric information affect the firm’s capital structure decisions?How do the firm’s financing actions give investors signals that reflect management’s view of stock value?
12–10 Briefly describe the agency problem that exists between owners and lenders. How do lenders cause firms to incur agency costs to resolve this problem?
12–9 What are business risk and financial risk? How does each of them influence the firm’s capital structure decisions?
12–8 What is the major benefit of debt financing? How does it affect the firm’s cost of debt?
12–7 In what ways are the capital structures of U.S. and non–U.S. firms different? How are they similar?
12–6 What is a firm’s capital structure? What ratios assess the degree of financial leverage in a firm’s capital structure?
12–5 What is the general relationship among operating leverage, financial leverage, and the total leverage of the firm? Do these types of leverage complement one another? Why or why not?
12–4 What is financial leverage? What causes it? How is the degree of financial leverage (DFL) measured?
12–3 What is operating leverage? What causes it? How is the degree of operating leverage (DOL) measured?
12–2 What is the operating breakeven point? How do changes in fixed operating costs, the sale price per unit, and the variable operating cost per unit affect it?
12–1 What is meant by the term leverage? How are operating leverage, financial leverage, and total leverage related to the income statement?
LG 6 R eview the return and risk of alternative capital structures, their linkage to market value, and other important considerations related to capital structure.
LG 5 Discuss the EBIT–EPS approach to capital structure.
LG 4 E xplain the optimal capital structure using a graphical view of the firm’s cost-of-capital functions and a zerogrowth valuation model.
LG 3 Describe the types of capital, external assessment of capital structure, the capital structure of non–U.S.firms, and capital structure theory.
LG 2 U nderstand operating, financial, and total leverage and the relationships among them.
LG 1 Discuss leverage, capital structure, breakeven analysis, the operating breakeven point, and the effect of changing costs on the breakeven point.
1. Assume that Monsanto Corporation is considering the replacement of some of its older and outdated carpet-manufacturing equipment. Its objective is to improve the efficiency of operations in terms
P1–6 ETHICS PROBLEM What does it mean to say that managers should maximize shareholder wealth “subject to ethical constraints”? What ethical considerations might enter into decisions that
P1–5 Identifying agency problems, costs, and resolutions Explain why each of the following situations is an agency problem and what costs to the firm might result from it.Suggest how the problem
P1–4 Marginal cost–benefit analysis and the goal of the firm Ken Allen, capital budgeting analyst for Bally Gears, Inc., has been asked to evaluate a proposal. The manager of the automotive
P1–2 Accrual income versus cash flow for a period Thomas Book Sales, Inc., supplies textbooks to college and university bookstores. The books are shipped with a proviso that they must be paid for
P1–1 Liability comparisons Merideth Harper has invested $25,000 in Southwest Development Company. The firm has recently declared bankruptcy and has $60,000 in unpaid debts. Explain the nature of
E1–5 Recently, some branches of Donut Shop, Inc., have dropped the practice of allowing employees to accept tips. Customers who once said, “Keep the change,” now have to get used to waiting for
E1–4 You have been made treasurer for a day at AIMCO, Inc. AIMCO develops technology for video conferencing. A manager of the satellite division has asked you to authorize a capital expenditure in
E1–3 The end-of-year parties at Yearling, Inc., are known for their extravagance. Management provides the best food and entertainment to thank the employees for their hard work.During the planning
E1–2 As chief financial officer, it is your responsibility to weigh the finanical pros and cons of the many investment opportunities developed by your company’s research and development division.
E1–1 Ann and Jack have been partners for several years. Their firm, A & J Tax Preparation, has been very successful, as the pair agree on most business-related questions.One disagreement, however,
1. Emphasis on Cash Flows Worldwide Rugs is a rug importer located in the United States that resells its import products to local retailers. Last year, Worldwide Rugs imported $2.5 million worth of
1-18 How do market forces—both shareholder activism and the threat of takeover—act to prevent or minimize the agency problem? What role do institutional investors play in shareholder activism?
1-17 How can the firm structure management compensation to minimize agency problems? What is the current view with regard to the execution of many compensation plans?
1-16 Define agency problems, and describe how they give rise to agency costs.Explain how a firm’s corporate governance structure can help avoid agency problems.
1-15 What is corporate governance? How has the Sarbanes-Oxley Act of 2002 affected it? Explain.
1–14 What are the two primary activities of the financial manager that are related to the firm’s balance sheet?
1–13 What are the major differences between accounting and finance with respect to emphasis on cash flows and decision making?
1–12 What is the primary economic principle used in managerial finance?
1–11 In what financial activities does a corporate treasurer engage?
1–10 Describe the role of corporate ethics policies and guidelines, and discuss the relationship that is believed to exist between ethics and share price.
1–9 What is risk? Why must risk as well as return be considered by the financial manager who is evaluating a decision alternative or action?
1–8 For what three main reasons is profit maximization inconsistent with wealth maximization?
1–7 What is the goal of the firm and, therefore, of all managers and employees?Discuss how one measures achievement of this goal.
2. What responsibility, if any, does Google have to protect the privacy of those who interact with other people wearing Glass? On June 27, 2012, at the Google I/O conference, Google introduced an
1. Is the goal of maximization of shareholder wealth necessarily ethical or unethical? On June 27, 2012, at the Google I/O conference, Google introduced an exciting new product called Glass.
1–6 Why is the study of managerial finance important to your professional life regardless of the specific area of responsibility you may have within the business firm? Why is it important to your
1–5 Briefly name and describe some organizational forms other than corporations that provide owners with limited liability.
1–4 Describe the roles and the relationships among the major parties in a corporation: stockholders, board of directors, and managers. How are corporate owners rewarded for the risks they take?
1–3 Which legal form of business organization is most common? Which form is dominant in terms of business revenues?
1–2 What is the financial services area of finance? Describe the field of managerial finance.
1–1 What is finance? Explain how this field affects all the activities in which businesses engage.
6.. Describe the nature of the principal–agent relationship between the owners and managers of a corporation, and explain how various corporate governance mechanisms attempt to manage agency
5.. I dentify the primary activities of the financial manager.
4.. Describe how the managerial finance function is related to economics and accounting.
3.. Describe the goal of the firm, and explain why maximizing the value of the firm is an appropriate goal for a business.
2.. Describe the legal forms of business organization.
1.. Define finance and the managerial finance function.
E8–5 You wish to calculate the risk level of your portfolio based on its beta. The five stocks in the portfolio with their respective weights and betas are shown in the accompanying table.
P8–2 Return calculations For each of the investments shown in the following table, calculate the rate of return earned over the unspecified time period. Investment Cash flow during period End-of-
P8–3 Risk preferences Sharon Smith, the financial manager for Barnett Corporation, wishes to evaluate three prospective investments: X, Y, and Z. Sharon will evaluate each of these investments to
P8–4 Risk analysis Solar Designs is considering an investment in an expanded product line. Two possible types of expansion are being considered. After investigating the possible outcomes, the
P8–5 Risk and probability Micro-Pub, Inc., is considering the purchase of one of two microfilm cameras, R and S. Both should provide benefits over a 10-year period, and each requires an initial
P8–6 Bar charts and risk Swan’s Sportswear is considering bringing out a line of designer jeans. Currently, it is negotiating with two different well-known designers. Because of the highly
P8–7 Coefficient of variation Metal Manufacturing has isolated four alternatives for meeting its need for increased production capacity. The following table summarizes data gathered relative to
P8–8 Standard deviation versus coefficient of variation as measures of risk Greengage, Inc., a successful nursery, is considering several expansion projects. All the alternatives promise to produce
P8–9 Rate of return, standard deviation, and coefficient of variation Mike is searching for a stock to include in his current stock portfolio. He is interested in Hi-Tech, Inc.; he has been
P8–10 Assessing return and risk Swift Manufacturing must choose between two asset purchases.The annual rate of return and the related probabilities given in the following table summarize the
P8–11 Integrative: Expected return, standard deviation, and coefficient of variation Three assets—F, G, and H—are currently being considered by Perth Industries. The probability distributions
P8–13 Portfolio return and standard deviation Jamie Wong is considering building an investment portfolio containing two stocks, L and M. Stock L will represent 40% of the dollar value of the
P8–14 Portfolio analysis You have been given the expected return data shown in the first table on three assets—F, G, and H—over the period 2016–2019.Using these assets, you have isolated the
P8–15 Correlation, risk, and return Matt Peters wishes to evaluate the risk and return behaviors associated with various combinations of assets V and W under three assumed degrees of correlation:
P8–17 Total, nondiversifiable, and diversifiable risk David Talbot randomly selected securities from all those listed on the New York Stock Exchange for his portfolio. He began with a single
P8–18 Graphical derivation of beta A firm wishes to estimate graphically the betas for two assets, A and B. It has gathered the return data shown in the following table for the market portfolio and
P8–19 Graphical derivation and interpreting beta You are analyzing the performance of two stocks. The first, shown in Panel A, is Cyclical Industries Incorporated. Cyclical Industries makes machine
P8–21 Betas Answer the questions below for assets A to D shown in the table.a. What impact would a 10% increase in the market return be expected to have on each asset’s return?b. What impact
P8–23 Portfolio betas Rose Berry is attempting to evaluate two possible portfolios, which consist of the same five assets held in different proportions. She is particularly interested in using beta
P8–24 Capital asset pricing model (CAPM) For each of the cases shown in the following table, use the capital asset pricing model to find the required return. Risk-free Market Case rate, RF return,
P8–27 Portfolio return and beta Jamie Peters invested $100,000 to set up the following portfolio 1 year ago.a. Calculate the portfolio beta on the basis of the original cost figures.b. Calculate
P8–30 Integrative: Risk, return, and CAPM Wolff Enterprises must consider several investment projects, A through E, using the capital asset pricing model (CAPM) and its graphical representation,
1.. Jane is considering investing in three different stocks or creating three distinct twostock portfolios. Jane considers herself to be a rather conservative investor. She is able to obtain
ST8–1 Portfolio analysis You have been asked for your advice in selecting a portfolio of assets and have been given the following data:You have been told that you can create two portfolios—one
P10–10 NPV: Mutually exclusive projects Hook Industries is considering the replacement of one of its old drill presses. Three alternative replacement presses are under consideration.The relevant
ST5–3 Present values of single amounts and streams You have a choice of accepting either of two 5-year cash flow streams or single amounts. One cash flow stream is an ordinary annuity, and the
E5–4 Your firm has the option of making an investment in new software that will cost$130,000 today and is estimated to provide the savings shown in the following table over its 5-year life.Should
P5–2 Future value calculation Without referring to the preprogrammed function on your financial calculator, use the basic formula for future value along with the given interest rate, r, and the
P5–4 Future values For each of the cases shown in the following table, calculate the future value of the single cash flow deposited today at the end of the deposit period if the interest is
P5–10 Present value calculation Without referring to the preprogrammed function on your financial calculator, use the basic formula for present value, along with the given opportunity cost, r, and
P5–11 Present values For each of the cases shown in the following table, calculate the present value of the cash flow, discounting at the rate given and assuming that the cash flow is received at
P5–16 Time value comparisons of single amounts In exchange for a $20,000 payment today, a well-known company will allow you to choose one of the alternatives shown in the following table. Your
P5–17 Cash flow investment decision Tom Alexander has an opportunity to purchase any of the investments shown in the following table. The purchase price, the amount of the single cash inflow, and
P5–19 Future value of an annuity For each case in the accompanying table, answer the questions that follow.a. Calculate the future value of the annuity, assuming that it is (1) An ordinary
P5–20 Present value of an annuity Consider the following cases.a. Calculate the present value of the annuity, assuming that it is (1) An ordinary annuity.(2) An annuity due.b. Compare your findings
P5–26 Perpetuities Consider the data in the following table.Determine the present value of each perpetuity. Perpetuity Annual amount Discount rate ABC A $ 20,000 8% 100,000 10 3,000 6 D 60,000 5
P5–28 Value of a mixed stream For each of the mixed streams of cash flows shown in the following table, determine the future value at the end of the final year if deposits are made into an account
P5–29 Value of a single amount versus a mixed stream Gina Vitale has just contracted to sell a small parcel of land that she inherited a few years ago. The buyer is willing to pay $24,000 at the
P5–30 Value of mixed streams Find the present value of the streams of cash flows shown in the following table. Assume that the firm’s opportunity cost is 12%. A B C Year Cash flow Year Cash flow
P5–31 Present value: Mixed streams Consider the mixed streams of cash flows shown in the following table.a. Find the present value of each stream using a 15% discount rate.b. Compare the calculated
P5–33 Funding budget shortfalls As part of your personal budgeting process, you have determined that in each of the next 5 years you will have budget shortfalls. In other words, you will need the

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