Question: ABC Co. and XYZ Co. are identical

> What are the prices of a call option and a put option with the following characteristics? Stock price = $57 Exercise price = $60 %3D Risk-free rate = 6% per year, compounded continuously Maturity = 4 months Standard deviation = 54% per year

> The Wildcat Oil Company is trying to decide whether to lease or buy a new computer-assisted drilling system for its oil exploration business. Management has decided that it must use the system to stay competitive; it will provide $2.9 million in annual p

> Teardrop, Inc., wishes to expand its facilities. The company currently has 6.8 million shares outstanding and no debt. The stock sells for $65 per share, but the book value per share is $20. Net income for Teardrop is currently $11.5 million. The new fac

> The Mann Company belongs to a risk class for which the appropriate discount rate is 10 percent. Mann currently has 240,000 outstanding shares selling at $105 each. The firm is contemplating the declaration of a $4 dividend at the end of the fiscal year t

> Triad Corporation has established a joint venture with Tobacco Road Construction, Inc., to build a toll road in North Carolina. The initial investment in paving equipment is $93 million. The equipment will be fully depreciated using the straight-line met

> Overnight Publishing Company (OPC) has $2.5 million in excess cash. The firm plans to use this cash either to retire all of its outstanding debt or to repurchase equity. The firm’s debt is held by one institution that is willing to sell it back to OPC fo

> Kose, Inc., has a target debt–equity ratio of .45. Its WACC is 9.8 percent, and the tax rate is 35 percent. a. If Kose’s cost of equity is 13 percent, what is its pretax cost of debt? b. If instead you know that the aftertax cost of debt is 5.9 percent,

> Assume that the returns on individual securities are generated by the following two-factor model: Here: Rα is the return on Security i at Time t. F1t and F2t are market factors with zero expectation and zero covariance. In addition, assume

> You own a stock portfolio invested 15 percent in Stock Q, 35 percent in Stock R, 30 percent in Stock S, and 20 percent in Stock T. The betas for these four stocks are .75, 1.90, 1.38, and 1.16, respectively. What is the portfolio beta?

> What happens to the price of a convertible bond if interest rates increase?

> Why does the value of a share of stock depend on dividends?

> In Problem 9, suppose the average inflation rate over this period was 4.2 percent, and the average T-bill rate over the period was 5.1 percent. a. What was the average real return on the company’s stock? b. What was the average nominal risk premium on th

> If Treasury bills are currently paying 3.9 percent and the inflation rate is 2.1 percent, what is the approximate real rate of interest? The exact real rate?

> Niko has purchased a brand new machine to produce its High Flight line of shoes. The machine has an economic life of five years. The depreciation schedule for the machine is straight-line with no salvage value. The machine costs $575,000. The sales price

> You are evaluating two different silicon wafer milling machines. The Techron I costs $245,000, has a three-year life, and has pretax operating costs of $39,000 per year. The Techron II costs $315,000, has a five-year life, and has pretax operating costs

> Vital Silence Corp. has just issued a 30-year callable, convertible bond with an annual coupon rate of 6 percent. The bond has a conversion price of $93. The company’s stock is selling for $28 per share. The owner of the bond will be forced to convert if

> You are in discussions to purchase an option on an office building with a strike price of $63 million. The building is currently valued at $60 million. The option will allow you to purchase the building either six months from today or one year from today

> The Spring Flower Co. has earnings of $2.35 per share. The benchmark PE for the company is 18. What stock price would you consider appropriate? What if the benchmark PE were 21?

> A warrant with six months until expiration entitles its owner to buy 10 shares of the issuing firm’s common stock for an exercise price of $31 per share. If the current market price of the stock is $15 per share, will the warrant be worthless?

> How would the analysis of real options change if a company has competitors?

> Utility companies often face a decision to build new plants that burn coal, oil, or both. If the prices of both coal and gas are highly volatile, how valuable is the decision to build a plant that can burn either coal or oil? What happens to the value of

> When you take out an ordinary student loan, it is usually the case that whoever holds that loan is given a guarantee by the U.S. government, meaning that the government will make up any payments you skip. This is just one example of the many loan guarant

> A convertible bond with a par value of $1,000 has a conversion ratio of 19.2. What is the conversion price?

> In April 2014, International Lease Finance Corporation (ILFC) announced a deal to purchase eight Airbus A330-200 and A350-900 passenger aircraft. ILFC then signed a long-term lease contract on the planes with Azul Linhas Aéreas Brasileiras to be used for

> The Phew Charitable Trust pays no taxes on its capital gains or on its dividend income or interest income. Would it be irrational for it to have low-dividend, high-growth stocks in its portfolio? Would it be irrational for it to have municipal bonds in i

> What is the difference between internal financing and external financing?

> For each of the following scenarios, discuss whether profit opportunities exist from trading in the stock of the firm under the conditions that (1) the market is not weak form efficient, (2) the market is weak form but not semistrong form efficient, (3)

> What factors determine the beta of a stock? Define and describe each.

> Is the following statement true or false? A risky security cannot have an expected return that is less than the risk-free rate because no risk-averse investor would be willing to hold this asset in equilibrium. Explain.

> The historical asset class returns presented in the chapter are not adjusted for inflation. What would happen to the estimated risk premium if we did account for inflation? The returns are also not adjusted for taxes. What would happen to the returns if

> Comment on the following remarks: a. Leasing reduces risk and can reduce a firm’s cost of capital. b. Leasing provides 100 percent financing. c. If the tax advantages of leasing were eliminated, leasing would disappear.

> You are discussing a project analysis with a coworker. The project involves real options, such as expanding the project if successful, or abandoning the project if it fails. Your coworker makes the following statement: “This analysis is ridiculous. We lo

> Consider the following two mutually exclusive projects available to Global Investments, Inc.: The appropriate discount rate for the projects is 10 percent. Global Investments chose to undertake Project A. At a luncheon for shareholders, the manager of

> In the context of capital budgeting, what is an opportunity cost?

> Is it unfair or unethical for corporations to create classes of stock with unequal voting rights?

> What is the difference between the term structure of interest rates and the yield curve?

> Insurance, whether purchased by a corporation or an individual, is in essence an option. What type of option is an insurance policy?

> Suppose the interest rate on T-bills suddenly and unexpectedly rises. All other things being the same, what is the impact on call option values? On put option values?

> Explain why the aftertax borrowing rate is the appropriate discount rate to use in lease evaluation.

> In 1980, a certain assistant professor of finance bought 12 initial public offerings of common stock. He held each of these for approximately one month and then sold them. The investment rule he followed was to submit a purchase order for every firm comm

> Firms sometimes use the threat of a bankruptcy filing to force creditors to renegotiate terms. Critics argue that in such cases the firm is using bankruptcy laws “as a sword rather than a shield.” Is this an ethical tactic?

> What steps can stockholders take to reduce the costs of debt?

> What is homemade leverage?

> A project has an initial cost of I, has a required return of R, and pays C annually for N years. a. Find C in terms of I and N such that the project has a payback period just equal to its life. b. Find C in terms of I, N, and R such that this is a profit

> The Newton Company has 50,000 shares of stock that each sell for $40. Suppose the company issues 9,000 shares of new stock at the following prices: $40, $20, and $10. What is the effect of each of the alternative offering prices on the existing price per

> What is the primary difference between a warrant and a traded call option?

> In the previous problem, suppose the company instead decides on a five-for-one stock split. The firm’s 45 cent per share cash dividend on the new (postsplit) shares represents an increase of 10 percent over last year’s dividend on the presplit stock. Wha

> Bolero, Inc., has compiled the following information on its financing costs: The company is in the 35 percent tax bracket and has a target debt–equity ratio of 60 percent. The target short-term debt/long-term debt ratio is 20 percent.

> When personal taxes on interest income and bankruptcy costs are considered, the general expression for the value of a levered firm in a world in which the tax rate on equity distributions equals zero is: where: VL = The value of a levered firm. VU = The

> In the previous problem, suppose the company’s stock has a beta of 1.15. The risk-free rate is 3.7 percent, and the market risk premium is 7 percent. Assume that the overall cost of debt is the weighted average implied by the two outstanding debt issues.

> Assume that the following market model adequately describes the return-generating behavior of risky assets: Here: Rit = The return on the ith asset at Time t. RMt = The return on a portfolio containing all risky assets in some proportion at Time t. RMt a

> T-bills currently yield 3.9 percent. Stock in Nina Manufacturing is currently selling for $63 per share. There is no possibility that the stock will be worth less than $61 per share in one year. a. What is the value of a call option with a $60 exercise p

> Consider the following information: a. Your portfolio is invested 30 percent each in A and C, and 40 percent in B. What is the expected return of the portfolio? b. What is the variance of this portfolio? The standard deviation? Rate of Return if St

> You’ve observed the following returns on SkyNet Data Corporation’s stock over the past five years: 21 percent, 17 percent, 26 percent, 27 percent, and 4 percent. a. What was the arithmetic average return on the company’s stock over this five-year period?

> You are considering investing in a company that cultivates abalone for sale to local restaurants. Use the following information: The discount rate for the company is 15 percent, the initial investment in equipment is $840,000, and the projectâ&#1

> Howell Petroleum is considering a new project that complements its existing business. The machine required for the project costs $3.9 million. The marketing department predicts that sales related to the project will be $2.35 million per year for the next

> Why do companies issue options to executives if they cost the company more than they are worth to the executive? Why not just give cash and split the difference? Wouldn’t that make both the company and the executive better off?

> General Modems has five-year warrants that currently trade in the open market. Each warrant gives its owner the right to purchase one share of common stock for an exercise price of $55. a. Suppose the stock is currently trading for $51 per share. What is

> In the previous problem, assume that the exercise style on the option is American rather than European. What is the price of the option now? (Hint: How will you find the value of the option if it can be exercised early? When would you exercise the option

> The Wildcat Oil Company is trying to decide whether to lease or buy a new computer-assisted drilling system for its oil exploration business. Management has decided that it must use the system to stay competitive; it will provide $2.9 million in annual p

> The newspaper reported last week that Bennington Enterprises earned $29 million this year. The report also stated that the firm’s return on equity is 17 percent. Bennington retains 80 percent of its earnings. What is the firm’s earnings growth rate? What

> When should a firm force conversion of convertibles? Why?

> The yields on nonconvertible preferred stock are lower than the yields on corporate bonds. Why is there a difference? Which investors are the primary holders of preferred stock? Why?

> For initial public offerings of common stock, 2007 was a relatively slow year, with only about $35.6 billion raised by the process. Relatively few of the 159 firms involved paid cash dividends. Why do you think that most chose not to pay cash dividends?

> As was mentioned in the chapter, new equity issues are generally only a small portion of all new issues. At the same time, companies continue to issue new debt. Why do companies tend to issue little new equity but continue to issue new debt?

> Several celebrated investors and stock pickers frequently mentioned in the financial press have recorded huge returns on their investments over the past two decades. Does the success of these particular investors invalidate the EMH? Explain.

> Consider a levered firm’s projects that have similar risks to the firm as a whole. Is the discount rate for the projects higher or lower than the rate computed using the security market line? Why?

> What is data mining? Why might it overstate the relation between some stock attribute and returns?

> How is it possible that dividends are so important, but at the same time dividend policy is irrelevant?

> What rule should a firm follow when making financing decisions? How can firms create valuable financing opportunities?

> A broker has advised you not to invest in oil industry stocks because they have high standard deviations. Is the broker’s advice sound for a risk-averse investor like yourself? Why or why not?

> What is the difference between arithmetic and geometric returns? Suppose you have invested in a stock for the last 10 years. Which number is more important to you, the arithmetic or geometric return?

> An option can often have more than one source of value. Consider a logging company. The company can log the timber today or wait another year (or more) to log the timber. What advantages would waiting one year potentially have?

> A major college textbook publisher has an existing finance textbook. The publisher is debating whether to produce an “essentialized” version, meaning a shorter (and lower-priced) book. What are some of the considerations that should come into play?

> The investment in Project A is $1 million, and the investment in Project B is $2 million. Both projects have a unique internal rate of return of 20 percent. Is the following statement true or false? For any discount rate from 0 percent to 20 percent, Pro

> What are the three factors that determine a company’s price−earnings ratio?

> You own a callable, convertible bond with a conversion ratio of 25.18. The stock is currently selling for $47 per share. The issuer of the bond has announced a call at a call price of 110. What are your options here? What should you do?

> How does sensitivity analysis interact with break-even analysis?

> Why will convertible bonds not be voluntarily converted to stock before expiration?

> Your company currently uses traditional capital budgeting techniques, including net present value. After hearing about the use of real option analysis, your boss decides that your company should use real option analysis in place of net present value. How

> How is the APV of a project calculated?

> Suppose a certain stock currently sells for $30 per share. If a put option and a call option are available with $30 exercise prices, which do you think will sell for more? Explain.

> Ren-Stimpy International is planning to raise fresh equity capital by selling a large new issue of common stock. Ren-Stimpy is currently a publicly traded corporation, and it is trying to choose between an underwritten cash offer and a rights offering (n

> What are the advantages of using the SML approach to finding the cost of equity capital? What are the disadvantages? What are the specific pieces of information needed to use this method? Are all of these variables observable, or do they need to be estim

> Why is the use of debt financing referred to as financial “leverage”?

> Do you think preferred stock is more like debt or equity? Why?

> Critically evaluate the following statements: Playing the stock market is like gambling. Such speculative investing has no social value other than the pleasure people get from this form of gambling.

> How can the return on a portfolio be expressed in terms of a factor model?

> Suppose the following two independent investment opportunities are available to Relax, Inc. The appropriate discount rate is 8.5 percent. a. Compute the profitability index for each of the two projects. b. Which project(s) should the company accept bas

> Good Time Company is a regional chain department store. It will remain in business for one more year. The probability of a boom year is 60 percent and the probability of a recession is 40 percent. It is projected that the company will generate a total ca

> Star, Inc., a prominent consumer products firm, is debating whether or not to convert its all-equity capital structure to one that is 35 percent debt. Currently there are 6,000 shares outstanding and the price per share is $58. EBIT is expected to remain

> KIC, Inc., plans to issue $5 million of bonds with a coupon rate of 8 percent and 30 years to maturity. The current market interest rates on these bonds are 7 percent. In one year, the interest rate on the bonds will be either 10 percent or 6 percent wit

> If you can borrow all the money you need for a project at 6 percent, doesn’t it follow that 6 percent is your cost of capital for the project?

> Filer Manufacturing has 8.3 million shares of common stock outstanding. The current share price is $53, and the book value per share is $4. The company also has two bond issues outstanding. The first bond issue has a face value of $70 million and a coupo

> The Starr Co. just paid a dividend of $1.95 per share on its stock. The dividends are expected to grow at a constant rate of 4.5 percent per year, indefinitely. If investors require a return of 11 percent on the stock, what is the current price? What wil

> There are two stock markets, each driven by the same common force, F, with an expected value of zero and standard deviation of 10 percent. There are many securities in each market; thus, you can invest in as many stocks as you wish. Due to restrictions,

> Consider the following information: a. What is the expected return on an equally weighted portfolio of these three stocks? b. What is the variance of a portfolio invested 20 percent each in A and B, and 60 percent in C? State of Rate of

> Refer to Table 10.1(given below) in the text and look at the period from 1973 through 1978. a. Calculate the arithmetic average returns for large-company stocks and T-bills over this period. b. Calculate the standard deviation of the returns for large-

> B&B has a new baby powder ready to market. If the firm goes directly to the market with the product, there is only a 55 percent chance of success. However, the firm can conduct customer segment research, which will take a year and cost $950,000. By going

> An asset used in a four-year project falls in the five-year MACRS class for tax purposes. The asset has an acquisition cost of $8,300,000 and will be sold for $1,700,000 at the end of the project. If the tax rate is 35 percent, what is the aftertax salva