Questions and Answers of Theory Of Corporate Finance

The interest rate has just increased from 6% to 8%. How many basis points is this?
Your stock costs $100 today, pays $5 in dividends at the end of the period, and then sells for $98.What is your rate of return?
In the text, I assumed you received the dividend at the end of the period. In the real world, if you received the dividend at the beginning of the period instead of the end of the period, could this
What is the difference between a bond and a loan?
What is a perfect market? What were the assumptions made in this chapter that were not part of the perfect market scenario?
No! The market will already have adjusted the price.
Again, call 2000 your year 0. The firm’s present value in 2000 is based on dividends of $100, $150, and $250 in the next three years. The firm value in 2000 is the $402.70 from page 33. The firm
For easier naming, call 2000 your year 0. The firm’s present value in 2000 is $536/1.103 ≈ $402.70—but you already knew this. If you purchase this company, its value in 2001 depends on a cash
Lease A has an NPV of −$6,535. Lease B has an NPV of −$6,803. Therefore, lease A is cheaper.
For the 3-year building leases:(a) Your preference depends on the interest rate. If the interest rate is zero, then you would prefer the $2 million sum-total payment to the $2.1 million rent. If the
−$900 + $200/(1.08)1 + $200/(1.08)2 + $400/(1.08)3 + $400/(1.08)4 − $100/(1.08)5 ≈ $0.14. The NPV is positive. Therefore this is a worthwhile project that you should accept.
Accept if NPV is positive. Reject if NPV is negative.
If you cannot write down the NPV formula by heart, do not go on until you have it memorized.
The first tuition payment is worth $30,000/(1.06)1/2 ≈ $29,139. The second tuition payment is worth$30,000/(1.06)3/2 ≈ $27,489. Thus, the total present value is $56,628.
The original interest rate is $100/$95 − 1 ≈ 5.26%. Increasing the interest rate by 150 basis points is 6.76%.This means that the price should be $100/(1.0676) ≈ $93.67. A price change from $95
Good. Your future payments would be worth less in today’s money.
The rate of return and additional factors are unit-less. The latter two are in dollars (though the former is dollars in the future, while the latter is dollars today).
It is today’s value in dollars for 1 future dollar, that is, at a specific point in time in the future.
1/[(1.05) . (1.05)] ≈ 0.9070
$150/[1 + (5%/365)]365 ≈ $142.68
$150/(1.05) ≈ $142.86
r = 30% = ($250 − x)/x. Thus, x = $250/1.30 ≈ $192.31.
The bank quote of 8% means that you will have to pay an interest rate of 8%/12 ≈ 0.667% per month. This earns an actual interest rate of (1 + 0.667%)12 − 1 ≈ 8.30% per annum. You will have to
The bank quote of 6% means that it will pay an interest rate of 6%/365 ≈ 0.0164384% per day. This earns an actual interest rate of (1 + 0.0164384%)365 − 1 ≈ 6.18% per annum. Therefore, each
With 12% in nominal APR interest quoted, you earn 12%/365 ≈ 0.032877% per day. Therefore, the annual rate of return is (1 + 0.032877%)365 − 1 ≈ 12.747462%. Your $100,000 will grow into
With 12% in nominal APR interest quoted, you earn 12%/365 ≈ 0.032877% per day. Therefore, the weekly rate of return is (1 + 0.032877%)7 − 1 ≈ 0.23036%. Your $100,000 will grow into $100,230.36.
The true daily interest rate, assuming 365 days, is 1.121/365 − 1 ≈ 0.031054%. To compute your true rate of return, compound this over 7 days: (1 + 0.03105%)7 = 1.000310547 ≈ 1.0021758. (You
The bank means to collect 12%/365 ≈ 3.288 bp/day.
(1 + r)365 = 1.12. Therefore, 1.12(1/365) − 1 ≈ 0.00031054 = 0.031054% ≈ 3.1 bp/day.
Tripling is equivalent to earning a rate of return of 200%. Therefore, solve (1 + 6%)x = (1 + 200%), or x . log(1.06) = log(3.00) or x = log(3.00)/ log(1.06) ≈ 18.85 years.
r100= (1 + r1)100 − 1 = 1.05100 − 1 = 130.5 ≈ 13,050%. In words, this is about 130 times the initial investment, and substantially more than 500% (5 times the initial investment).
r10= (1 + r1)10 − 1 = 1.0510 − 1 ≈ 62.89%
r2= (1 + r0, 1) . (1 + r1, 2) − 1 = 1.05 . 1.05 − 1 = 10.25%
(1 + r0.25)4 = (1 + r1). Thus, r0.25= 4√1 + r1− 1 = 1.51/4 − 1 ≈ 10.67%.
(1 + 100%)1/5 − 1 ≈ 14.87%
Losing one-third is a rate of return of −33%. To find the holding rate of return, compute [1 + (−1/3)]5 − 1≈ −86.83%. About (1 − 86.83%) . $20,000 ≈ $2,633.74 remains.
The total holding rate of return is 1.0520 − 1 ≈ 165.33%, so you would end up with $200 .(1 + 165.33%) ≈ $530.66.
$2,000 . 1.2515 ≈ $56,843.42
1.205 − 1 ≈ 148.83%
r = 30% = (x − $250)/$250 ⇒ x = 1.3 . $250 = $325
20 basis points are 0.2%, so the interest rate declined from 10.0% to 9.8%.
1% = 100 basis points, so an increase of 3% is 300 basis points.
The dividend yield would be $1/$40 = 2.5%, the capital gain would be $45 − $40 = $5, so that its capital gain yield would be $5/$40 = 12.5%, and the total rate of return would be ($46 − $40)/$40
Yes, 10 = 1,000%.
r = $25$1, 000= 2.5%
r = ($1,050 − $1,000)/$1,000 = 5%
A savings deposit is an investment in a series of short-term bonds.
The four perfect market assumptions are no taxes, no transaction costs, no differences in opinions, and no large buyers or sellers.
One month ago, a firm suffered a large court award against it that will force it to pay compensatory damages of $100 million next January 1.Are shares in this firm a bad buy until January 2?
Assume that company G pays out the full cash flows (refer to the text example) in earnings each period.What is G’s market value at time 1, 2, and 3?What is your rate of return in each year?
Assume that company G pays no interim dividends, so you receive $536 at the end of the project. What is G’s market value at time 1, 2, and 3?What is your rate of return in each year? Assume that
Use a spreadsheet to answer the following question: Car dealer A offers a car for $2,200 up front (first payment), followed by $200 lease payments over the next 23 months. Car dealer B offers the
You are considering a 3-year lease for a building, where you have to make one payment now, one in a year, and a final one in 2 years.(a) Would you rather pay $1,000,000 up front, then $500,000 each
Determine the NPV of the project in Table 2.1, if the per-period interest rate were 8% per year, not 5%. Should you take this project?
What is the NPV capital budgeting rule?
Write down the NPV formula from memory.
Work out the present value of your tuition payments for the next 2 years.Assume that the tuition is $30,000 per year, payable at the start of the year. Your first tuition payment will occur in
The price of a bond that offers a safe promise of $100 in 1 year is $95.What is the implied interest rate? If the bond’s interest rate suddenly jumped up by 150 basis points, what would the bond
Would it be good or bad for you, in terms of the present value of your liabilities, if your opportunity cost of capital increased?
What are the units on rates of return, discount factors, future values, and present values?
Interpret the meaning of the discount factor.
If the cost of capital is 5% per annum, what is the discount factor for a cash flow in 2 years?
A bond promises to pay $150 in 12 months. The bank quotes you interest of 5% per annum, compounded daily. What is the bond’s price today?
A bond promises to pay $150 in 12 months. The annual true interest rate is 5% per annum.What is the bond’s price today?
A project has a cost of capital of 30%. The final payoff is $250. What should it cost today?
If the bank quotes a loan APR rate of 8% per annum, compounded monthly, and there are no fees, what do you have to pay back in 1 year if you borrow $100 from the bank?
If the bank quotes an interest rate of 6% per annum, what does a deposit of $100 in the bank come to after 1 year?
If the bank quotes interest of 12% per annum, and there are 52.15 weeks, how much interest do you earn on a deposit of $100,000 over 1 year?
If the bank quotes interest of 12% per annum, and there are 52.15 weeks, how much interest do you earn on a deposit of $100,000 over 1 week?
If the bank states an effective interest rate of 12% per annum, and there are 52.15 weeks, howmuch interest do you earn on a deposit of $100,000 over 1 week?
If the bank quotes an interest rate of 12% per annum (not as an effective interest rate), how many basis points do you earn in interest on a typical day?
If you earn an (effective) interest rate of 12% per annum, how many basis points do you earn in interest on a typical calendar day?
At a constant rate of return of 6% per annum, how many years does it take you to triple your money?
If the per-year interest rate is 5%, what is the 100-year total interest rate?How does this compare to 100 times 5%?
If the per-year interest rate is 5%, what is the 10-year total interest rate?
If the per-year interest rate is 5%, what is the 2-year total interest rate?
What is the quarterly interest rate if the annual interest rate is 50%?
If the 5-year holding rate of return is 100% and interest rates are constant, what is the (compounding) annual interest rate?
A project lost one-third of its value each year for 5 years. What was its total holding rate of return? How much is left if the original investment was $20,000?
What is the holding rate of return for a 20-year investment that earns 5%/year each year?What would a $200 investment grow to?
If you invest $2,000 today and it earns 25% per year, how much will you have in 15 years?
If the 1-year rate of return is 20% and interest rates are constant, what is the 5-year holding rate of return?
A project has a rate of return of 30%. What is the payoff if the initial investment is $250?
If the interest rate of 10% decreased by 20 basis points, what is the new interest rate?
If the interest rate of 9% increases to 12%, how many basis points did it increase?
You purchase a stock for $40 per share today. It will pay a dividend of$1 next month. If you can sell it for $45 right after the dividend is paid, what would be its dividend yield, what would be its
Is 10 the same as 1,000%?
A project offers a net return of $25 for an investment of $1,000.What is the rate of return?
A project offers a return of $1,050 for an investment of $1,000. What is the rate of return?
Is a deposit into a savings account more like a long-term bond investment or more like a series of short-term bond investments?
What are the four perfect market assumptions?
What is the difference between the value of all outstanding obligations and all outstanding stocks versus the value of all underlying assets?
What is the difference between investing in the stock and investing in the bond of a corporation?Which one is the less risky investment and why?
A degree program costs $50,000 in total expenses:$30,000 in tuition and $20,000 in housing and books. The U.S. government provides a grant for $10,000 of the tuition. Moreover, the university pays
Maximizing the value of the firm.
Absolutely yes. Indeed, the law of one price is the foundation upon which all project choice is based.
Inflows: Value of implicit rent. Capital gain if house appreciates. Outflows: Maintenance costs. Transaction costs. Mortgage costs. Real estate tax. Uninsured potential losses. Capital loss if house
Definitely yes. Forgone salary is a cost that you are bearing. This can be reasonably estimated, and many economic consulting firms regularly do so. As to (partly) nonmonetary benefits, there is the
Here are my own judgment calls.(a) Easy. There are many foreign currency transactions, so you can easily figure out how many U.S. dollars you can get for 10,000 euros. You can find this exchange
=+(c) Use the updated cash flow forecast (10.4b) and the WACC (10.4a) to calculate the NPV and the IRR of the project. Should ROOT go ahead with the project?Explain your answer.

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