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business
principles of finance

Questions and Answers of Principles Of Finance

Portfolio Return The table below shows your stock positions at the beginning of the year, the dividends that each stock paid during the year, and the stock prices at the end of the year. What is your
Risk, Return, and Their Relationship Consider the following annual returns of Estee Lauder and Lowe's Companies:Compute each stock's average return, standard deviation, and coefficient of variation.
Risk, Return, and Their Relationship Consider the following annual returns of Molson Coors and International Paper:Compute each stock's average return, standard deviation, and coefficient of
Spreadsheet Problem Below are the monthly returns for May 2005 to October 2010 of three international stock indices: All Ordinaries of Aus- tralia, Nikkei 225 of Japan, and FTSE 100 of England. a.
Consider an asset that provides the same return no matter what economic state occurs. What would be the standard deviation (or risk) of this asset? Explain. (LG1)
Why is expected return considered "forward-looking"? What are the chal- lenges for practitioners to utilize expected return? (LG1)
In 2000, the S&P 500 Index earned -9.1 percent while the T-bill yield was 5.9 percent. Does this mean the market risk premium was negative? Explain. (LG2)
How might the magnitude of the market risk premium impact people's desire to buy stocks? (LG2)
Describe how adding a risk-free security to modern portfolio theory allows investors to do better than the efficient frontier. (LG3)
Show on a graph like Figure 10.2 where a stock with a beta of 1.3 would be located on the security market line. Then show where that stock would be located if it is undervalued. (LG3)
Cisco Systems has a beta of 1.25. Does this mean that you should expect Cisco to earn a return 25 percent higher than the S&P 500 Index return? Explain. (LG4)
Note from Table 10.2 that some technology-oriented firms (Intel) in the Dow Jones Industrial Average have high market risk while others (AT&T and Verizon) have low market risk. How do you explain
Find a beta estimate from three different sources for General Electric (GE). Compare these three values. Why might they be different? (LG4)
Explain how the concept of a positive risk-return relationship breaks down if you can systematically find stocks that are overvalued and undervalued. (LG5)
Determine what level of market efficiency each event is consistent with:a. Immediately after an earnings announcement the stock price jumps and then stays at the new level. (LG5)b. The CEO buys
Why do most investment scams conducted over the Internet and e-mail involve penny stocks instead of S&P 500 Index stocks? (LG5)
Describe a stock market bubble. Can a bubble occur in a single stock? (LG5)
If stock prices are not strong-form efficient, then what might be the price reaction to a firm announcing a stock buyback? Explain. (LG6)
Compare and contrast the assumptions that need to be made to com- pute a required return using CAPM and the constant-growth model. (LG7)
How should you handle a case where required return computations from CAPM and the constant-growth model are very different? (LG7)
How would you handle calculating the cost of capital if a firm were planning to issue two different classes of common stock? (LG1)
Why don't we multiply the cost of preferred stock by 1 minus the tax rate, as we do for debt? (LG2)
Expressing WACC in terms of it, ip, and in, what is the theoretical minimum for the WACC? (LG2)
Under what situations would you want to use the CAPM approach for estimating the component cost of equity? The constant-growth model? (LG3)
Why do we use market-based weights instead of book-value-based weights when computing the WACC? (LG4)
Explain why the divisional cost of capital approach may cause problems if new projects are assigned to the wrong division. (LG6)
When will the subjective approach to forming divisional WACCs be better than using the firmwide WACC to evaluate all projects? (LG7)
Suppose a new project was going to be financed partially with retained earnings. What flotation costs should you use for retained earnings? (LG8)
Cost of Equity Diddy Corp. stock has a beta of 1.2, the current risk-free rate is 5 percent, and the expected return on the market is 13.5 percent. What is Diddy's cost of equity? (LG3)
Cost of Equity JaiLai Cos. stock has a beta of 0.9, the current risk-free rate is 6.2 percent, and the expected return on the market is 12 percent. What is JaiLai's cost of equity? (LG3)
Cost of Debt Oberon, Inc., has a $20 million (face value) 10-year bond issue selling for 97 percent of par that pays an annual coupon of 8.25 percent. What would be Oberon's before-tax component cost
Cost of Debt Katy Did Clothes has a $150 million (face value) 30-year bond issue selling for 104 percent of par that carries a coupon rate of 11 percent, paid semiannually. What would be Katydid's
Tax Rate Suppose that LilyMac Photography expects EBIT to be approxi- mately $200,000 per year for the foreseeable future, and that it has 1,000 10-year, 9 percent annual coupon bonds outstanding.
Tax Rate PDQ, Inc., expects EBIT to be approximately $11 million per year for the foreseeable future, and that it has 25,000 20-year, 8 percent annual coupon bonds outstanding. What would the
Cost of Preferred Stock ILK has preferred stock selling for 97 percent of par that pays an 8 percent annual coupon. What would be ILK's compo- nent cost of preferred stock? (LG3)
Cost of Preferred Stock Marme, Inc., has preferred stock selling for 96 percent of par that pays an 11 percent annual coupon. What would be Marme's component cost of preferred stock? (LG3)
Weight of Equity FarCry Industries, a maker of telecommunications equipment, has 2 million shares of common stock outstanding, 1 million shares of preferred stock outstanding, and 10,000 bonds. If
Weight of Equity OMG Inc. has 4 million shares of common stock outstanding, 3 million shares of preferred stock outstanding, and 5,000 bonds. If the common shares are selling for $17 per share, the
Weight of Debt FarCry Industries, a maker of telecommunications equipment, has 2 million shares of common stock outstanding, 1 mil- lion shares of preferred stock outstanding, and 10,000 bonds. If
Weight of Debt OMG Inc. has 4 million shares of common stock outstanding, 3 million shares of preferred stock outstanding, and 5,000 bonds. If the common shares are selling for $27 per share, the
Weight of Preferred Stock FarCry Industries, a maker of telecommuni- cations equipment, has 2 million shares of common stock outstanding, 1 million shares of preferred stock outstanding, and 10,000
Weight of Preferred Stock OMG Inc. has 4 million shares of common stock outstanding, 3 million shares of preferred stock outstanding, and 5,000 bonds. If the common shares sell for $17 per share, the
WACC Suppose that Tap Dance, Inc.'s, capital structure features 65 percent equity, 35 percent debt, and that its before-tax cost of debt is 8 percent, while its cost of equity is 13 percent. If the
WACC Suppose that JB Cos. has a capital structure of 78 percent equity, 22 percent debt, and that its before-tax cost of debt is 11 percent while its cost of equity is 15 percent. If the appropriate
WACC Suppose that B2B, Inc., has a capital structure of 37 percent equity, 17 percent preferred stock, and 46 percent debt. If the before-tax component costs of equity, preferred stock, and debt are
WACC Suppose that MNINK Industries' capital structure features 63 percent equity, 7 percent preferred stock, and 30 percent debt. If the before-tax component costs of equity, preferred stock, and
WACC TAFKAP Industries has 3 million shares of stock outstanding selling at $17 per share, and an issue of $20 million in 7.5 percent annual coupon bonds with a maturity of 15 years, selling at 106
WACC Johnny Cake Ltd. has 10 million shares of stock outstanding selling at $23 per share and an issue of $50 million in 9 percent annual coupon bonds with a maturity of 17 years, selling at 93.5
WACC Weights BetterPie Industries has 3 million shares of common stock outstanding, 2 million shares of preferred stock outstanding, and 10,000 bonds. If the common shares are selling for $47 per
WACC Weights WhackAmOle has 2 million shares of common stock outstanding, 1.5 million shares of preferred stock outstanding, and 50,000 bonds. If the common shares are selling for $63 per share, the
Flotation Cost Suppose that Brown-Murphies' common shares sell for $19.50 per share, that the firm is expected to set their next annual dividend at $0.57 per share, and that all future dividends are
Flotation Cost A firm is considering a project that will generate per- petual after-tax cash flows of $15,000 per year beginning next year. The project has the same risk as the firm's overall
Firmwide vs. Project-Specific WACCS An all-equity firm is considering the projects shown below. The T-bill rate is 4 percent and the market risk premium is 7 percent. If the firm uses its current
Firmwide vs. Project-Specific WACCS An all-equity firm is considering the projects shown below. The T-bill rate is 4 percent and the market risk premium is 7 percent. If the firm uses its current
Divisional WACCS Suppose your firm has decided to use a divisional WACC approach to analyze projects. The firm currently has four divi- sions, A through D, with average betas for each division of
Divisional WACCS Suppose your firm has decided to use a divisional WACC approach to analyze projects. The firm currently has four divi- sions, A through D, with average betas for each division of
How is the pro forma statement we used in this chapter for computing OCF different from an accountant's income statement? (LG1)
Why does a decrease in NWC result in a cash inflow to the firm? (LG3)
Everything else held constant, would you rather depreciate a project with straight-line depreciation or with DDB? (LG4)
Everything else held constant, would you rather depreciate a project with DDB depreciation or deduct it under a Section 179 deduction? (LG4)
In a replacement problem, would we ever see changes in NWC? (LG5)
In a replacement problem, will incremental net depreciation always be less than the gross depreciation on the new piece of equipment? (LG5)
In a cost-cutting proposal, what might cause you to sometimes have nega- tive EBIT? (LG6)
How many TVM formulas do you use every time you calculate EAC for a project? (LG7)
Will an increase in flotation costs increase or decrease the initial cash flow for a project? (LG8)
After-Tax Cash Flow from Sale of Assets Suppose you sell a fixed asset for $109,000 when its book value is $129,000. If your company's marginal tax rate is 39 percent, what will be the effect on cash
PV of Depreciation Tax Benefits Your company is considering a new project that will require $1 million of new equipment at the start of the project. The equipment will have a depreciable life of 10
EAC Approach You are trying to pick the least-expensive car for your new delivery service. You have two choices: the Scion xA, which will cost $14,000 to purchase and which will have OCF of -$1,200
EAC Approach You are evaluating two different cookie-baking ovens. The Pillsbury 707 costs $57,000, has a 5-year life, and has an annual OCF (after tax) of -$10,000 per year. The Keebler
EAC Approach You are considering the purchase of one of two machines used in your manufacturing plant. Machine A has a life of two years, costs $80 initially, and then $125 per year in maintenance
Project Cash Flows KADS, Inc., has spent $400,000 on research to develop a new computer game. The firm is planning to spend $200,000 on a machine to produce the new game. Shipping and installation
Depreciation Tax Shield Your firm needs a computerized machine tool lathe which costs $50,000 and requires $12,000 in maintenance for each year of its 3-year life. After three years, this machine
After-Tax Cash Flow from Sale of Assets If the lathe in the previous problem can be sold for $5,000 at the end of year 3, what is the after-tax salvage value? (LG4)
Project Cash Flows You have been asked by the president of your com- pany to evaluate the proposed acquisition of a new special-purpose truck for $60,000. The truck falls into the MACRS 3-year class,
Change in NWC You are evaluating a project for The Tiff-any golf club, guaranteed to correct that nasty slice. You estimate the sales price of The Tiff-any to be $400 per unit and sales volume to be
Operating Cash Flow Continuing the previous problem, what is the operating cash flow for the project in year 2? (LG3)
Project Cash Flows You are evaluating a project for The Ultimate recre- ational tennis racket, guaranteed to correct that wimpy backhand. You estimate the sales price of The Ultimate to be $400 per
Project Cash Flows Mom's Cookies, Inc., is considering the purchase of a new cookie oven. The original cost of the old oven was $30,000; it is now five years old, and it has a current market value of
Is the set of cash flows depicted below normal or non-normal? Explain. (LG1) Time: 1 2 3 Cash flow -$100 -$50 -$80 50 5 $100 $100
Derive an accept/reject rule for IRR similar to equation 13-8 that would make the correct decision on cash flows that are non-normal, but which always have one large positive cash flow at time zero
Is it possible for a company to initiate two products that target the same market that are not mutually exclusive? (LG1)
Suppose that your company used "APV," or "All-the-Present Value- Except-CF," to analyze capital budgeting projects. What would this rule's benchmark value be? (LG3)
Under what circumstances could payback and discounted payback be equal? (LG2)
Could a project's MIRR ever exceed its IRR? (LG4)
Suppose a company wanted to double the firm's value with the next round of capital budgeting project decisions. To what would it set the PI benchmark to make this goal? (LG6)
Suppose a company faced different borrowing and lending rates. How would this range change the way that you would compute the MIRR statistic? (LG4)
NPV with Normal Cash Flows Compute the NPV for Project M and accept or reject the project with the cash flows shown below if the appro- priate cost of capital is 8 percent. (LG3) Project M Time: 1 2
NPV with Normal Cash Flows Compute the NPV statistic for Project Y and indicate whether the firm should accept or reject the project with the cash flows shown below if the appropriate cost of capital
NPV with Non-normal Cash Flows Compute the NPV statistic for Proj- ect U and recommend whether the firm should accept or reject the project with the cash flows shown below if the appropriate cost of
NPV with Non-normal Cash Flows Compute the NPV statistic for Proj- ect K and recommend whether the firm should accept or reject the project with the cash flows shown below if the appropriate cost of
Payback Compute the payback statistic for Project B and decide whether the firm should accept or reject the project with the cash flows shown below if the appropriate cost of capital is 12 percent
Payback Compute the payback statistic for Project A and recommend whether the firm should accept or reject the project with the cash flows shown below if the appropriate cost of capital is 8 percent
Discounted Payback Compute the discounted payback statistic for Project C and recommend whether the firm should accept or reject the project with the cash flows shown below if the appropriate cost of
Discounted Payback Compute the discounted payback statistic for Project D and recommend whether the firm should accept or reject the project with the cash flows shown below if the appropriate cost of
IRR Compute the IRR statistic for Project E and note whether the firm should accept or reject the project with the cash flows shown below if the appropriate cost of capital is 8 percent. (LG4)
IRR Compute the IRR statistic for project F and note whether the firm should accept or reject the project with the cash flows shown below if the appropriate cost of capital is 12 percent. (LG4)
MIRR Compute the MIRR statistic for Project I and indicate whether to accept or reject the project with the cash flows shown below if the appro- priate cost of capital is 12 percent. (LG4) Project I
MIRR Compute the MIRR statistic for Project J and advise whether to accept or reject the project with the cash flows shown below if the appro- priate cost of capital is 10 percent. (LG4) Project]
PI Compute the PI statistic for Project Z and advise the firm whether to accept or reject the project with the cash flows shown below if the appro- priate cost of capital is 8 percent. (LG6) Project
PI Compute the PI statistic for Project Q and indicate whether you would accept or reject the project with the cash flows shown below if the appro- priate cost of capital is 12 percent. (LG6) Project

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