Chapter 1 The Financial Manager and the Firm

What is the goal of the firm?

What is the main idea behind capital budgeting?

We know that there are two ways to finance a projectequity and debt. What are they? Holding all other variables constant, Firm A has a debt to equity ratio of 0.25, Firm B has a debt to equity ratio of 0.75; which one is riskier? Explain.

Chapter 2 Financial system and the level of interest rates

What are capital markets? What does it mean for the capital market to be efficient?

What is the relation between business cycles and the general level of interest rates? Why is the relationship this way?

What is the role of a financial intermediary in the market?

What is nominal rate? What is real rate of interest? If inflation is anticipated to be 5 percent during the next year, while the real rate of interest for a one-year loan is 5 percent, then what should the nominal rate of interest be for a risk-free one-year loan?

Chapter 5 The Time Value of Money

Why should we (managers) learn calculations involving the time value of money? What kind of management decisions does it help us make?

Emily Smith deposits $1,200 in her bank today. If the bank pays 4 percent simple interest, how much money will she have at the end of five years? What if the bank pays compound interest? How much of the earnings will be interest on interest?

Multiple compounding periods: Find the future value of a five-year $100,000 investment that pays 8.75 percent and that has the following compounding periods:

Yearly

Monthly.

Present value: Tracy Chapman is saving to buy a house in five years. She plans to put 20 percent down at that time, and she believes that she will need $35,000 for the down payment. If Tracy can invest in a fund that pays 9.25 percent annually, how much will she need to invest today?

Chapter 6: Discounted Cash Flow and Valuations

Kronka, Inc., is expecting cash inflows of $13,000, $11,500, $12,750, and $9,635 over the next four years. What is the present value of these cash flows if the appropriate discount rate is 8 percent?

Your grandfather has agreed to deposit a certain amount of money each year into an account paying 7.25 percent annually to help you go to graduate school. Starting next year, and for the following four years, he plans to deposit $2,250, $8,150, $7,675, $6,125, and $12,345 into the account. How much will you have at the end of the five years?

Effective annual interest rate: Cyclone Rentals borrowed $15,550 from a bank for three years. If the quoted rate (APR) is 6.75 percent, and the compounding is daily, what is the effective annual interest rate (EAR)?

Chapter 8: Bond valuation and structure of interest rate

What is a bond?

Explain conceptually how bonds are priced.

Can bond prices be affected by interest rate? Why?

What kind of bonds gets affected by interest rate most: long-term bonds with zero coupons are riskier than short-term bonds that pay coupon interest?

Bigbie Corp. issued a five-year bond a year ago with a coupon of 8 percent. The bond pays interest semiannually. If the yield to maturity on this bond is 9 percent, what is the price of the bond?

Hindenberg, Inc., has a 10-year bond that is priced at $1,100.00. It has a coupon of 8 percent paid semiannually. What is the yield to maturity on this bond?

Chapter 9: Stock Valuation

What is the general formula used to calculate the price of a share of a stock? What does it mean?

Ted McKay has just bought the common stock of Ryland Corp. The company expects to grow at the following rates for the next three years: 30 percent, 25 percent, and 15 percent. Last year the company paid a dividend of $2.50. Assume a required rate of return of 10 percent. Compute the expected dividends for the next three years and also the present value of these dividends.

Merriweather Manufacturing Company has been growing at a rate of 6 percent for the past two years, and the CEO expects the company to continue to grow at this rate for the next several years. The company paid a dividend of $1.20 last year. If your required rate of return is 14 percent, what is the maximum price that you would be willing to pay for this companys stock?

4. Rhea Kirby owns shares in Ryoko Corp. Currently, the market price of the stock is $36.34. Management expects dividends to grow at a constant rate of 6 percent for the foreseeable future. Its last dividend was $3.25. Rheas required rate of return for such stocks is 16 percent. She wants to find out whether she should sell her shares or add to her holdings.

a. What is the value of this stock?

b. Based on your answer to part a, should Rhea buy additional shares in Ryoko Corp? Why or why not?

Chapter 10: Fundamentals of Capital Budgeting

What is the payback period?

Why does the payback period provide a measure of a projects liquidity risk?

What are the main shortcomings of the payback method?

Net present value: Blanda Incorporated management is considering investing in two alternative production systems. The systems are mutually exclusive, and the cost of the new equipment and the resulting cash flows are shown in the accompanying table. If the firm uses a 9 percent discount rate for production system projects, in which system should the firm invest?

Year		System 1		System 2
0		-15,000		-45,000
1		15,000		32,000
2		15,000		32,000
3		15,000		32,000

Payback: Northern Specialties just purchased inventory-management computer software at a cost of $1,645,276. Cost savings from the investment over the next six years will produce the following cash flow stream: $212,455, $292,333, $387,479, $516,345, $645,766, and $618,325. What is the payback period on this investment?

What are the five steps used in NPV analysis?

Chapter 11: Cash Flows and Capital Budgeting

FCF and NPV for a project: Archer Daniels Midland Company is considering buying a new farm that it plans to operate for 10 years. The farm will require an initial investment of $12 million. This investment will consist of $2 million for land and $10 million for trucks and other equipment. The land, all trucks, and all other equipment are expected to be sold at the end of 10 years for a price of $5 million, which is $2 million above book value. The farm is expected to produce revenue of $2 million each year, and annual cash flow from operations equals $1.8 million. The marginal tax rate is 35 percent, and the appropriate discount rate is 10 percent. Calculate the NPV of this investment.

2 .	Expected cash flows: FireRock Wheel Corp is evaluating a project in which there is a 40 percent probability of revenues totaling $3 million and a 60 percent probability of revenues totaling $1 million per year. Its cash expenses will be $1.0 million while depreciation expense will be $200,000; then what is the expected free cash flow from taking the project if the marginal tax rate for the firm is 30 percent?

3.	Why is depreciation and amortization added back when calculating free cash flows generated by a project?

Chapter 7: Risk and Return

CAPM: Describe the Capital Asset Pricing Model (CAPM) and what it tells us.

The Security market line: If the expected return on the market is 10 percent and the risk-free rate is 4 percent, what is the expected return for a stock with a beta equal to 1.5? What is the market risk premium?

Diversification: Describe how investing in more than one asset can reduce risk through diversification.

Systematic risk: Define systematic risk.

You have just invested in a portfolio of three stocks. The amount of money that you invested in each stock and its beta are summarized below. Calculate the beta of the portfolio and use the capital asset pricing model (CAPM) to compute the expected rate of return for the portfolio. Assume that the expected rate of return on the market is 15 percent and that the risk-free rate is 7 percent.

Stock	Investment	Beta
A	$ 200,000	1.50
B	300,000	0.65
C	500,000	1.25

Chapter 13: Cost of Capital

How is the WACC for a firm calculated?

What does the WACC for a firm tell us?

Cost of common stock: Seerex Wok Co. is expected to pay a dividend of $1.10 one year from today on its common shares. That dividend is expected to increase by 5 percent every year thereafter. If the price of Seerex common stock is $13.75, what is the cost of its common equity capital?

Cost of preferred stock: Fjord Luxury Liners has preferred shares outstanding that pay an annual dividend equal to $15 per year. If the current price of Fjord preferred shares is $107.14, what is the after-tax cost of preferred stock for Fjord?

WACC: Capital Co. has a capital structure, based on current market values, that consists of 50 percent debt, 10 percent preferred stock, and 40 percent common stock. If the returns required by investors are 8 percent, 10 percent, and 15 percent for the debt, preferred equity, and common stock, respectively, what is Capitals after-tax WACC? Assume that the firms marginal tax rate is 40 percent.