Historically, the U.S. tax code treated dividend payments made to shareholders as ordinary income. Thus, dividends were taxed at the investor’s marginal tax rate, which was as high as 38.6 percent in 2002. Capital gains were taxed at a capital gains tax rate, which was the same for most investors and fluctuated through the years. In 2002, the capital gains tax rate stood at 20 percent. In an effort to stimulate the economy, President George W. Bush presided over a tax plan overhaul that included changes in dividend and capital gains tax rates. The new tax plan, which was implemented in 2003, called for a 15 percent tax rate on both dividends and capital gains for investors in higher tax brackets. For lower tax bracket investors, the tax rate on dividends and capital gains was set at 5 percent through 2007, dropping to zero in 2008. How do you think this tax law change affects the relative attractiveness of stock repurchases compared to dividend payments?
> L.J.’s Toys, Inc., just purchased a $375,000 machine to produce toy cars. The machine will be fully depreciated by the straight-line method over its five-year economic life. Each toy sells for $21. The variable cost per toy is $8, and the firm incurs fix
> You bought a share of 3.5 percent preferred stock for $92.07 last year. The market price for your stock is now $96.12. What was your total return for last year?
> Locate the Treasury bond in Figure 8.4(given below) maturing in February 2037. What is its coupon rate? What is its bid price? What was the previous day’s asked price? Assume a par value of $10,000. Treasury Notes & Bonds Asked Mat
> McGilla Golf has decided to sell a new line of golf clubs. The clubs will sell for $850 per set and have a variable cost of $430 per set. The company has spent $150,000 for a marketing study that determined the company will sell 60,000 sets per year for
> Vandalay Industries is considering the purchase of a new machine for the production of latex. Machine A costs $3,100,000 and will last for six years. Variable costs are 35 percent of sales, and fixed costs are $204,000 per year. Machine B costs $6,100,00
> You have been hired to value a new 20-year callable, convertible bond. The bond has a 5.8 percent coupon rate, payable annually. The conversion price is $150, and the stock currently sells for $32.20. The stock price is expected to grow at 12 percent per
> In the previous problem, suppose you wanted the option to sell the land to the buyer in one year. Assuming all the facts are the same, describe the transaction that would occur today. What is the price of the transaction today?
> Wolfson Corporation has decided to purchase a new machine that costs $2.8 million. The machine will be depreciated on a straight-line basis and will be worthless after four years. The corporate tax rate is 35 percent. The Sur Bank has offered Wolfson a f
> Valley Corp.’s stock is currently selling at $37 per share. There are 1 million shares outstanding. The firm is planning to raise $2.5 million to finance a new project. What are the ex-rights stock price, the value of a right, and the appropriate subscri
> The net income of Novis Corporation is $85,000. The company has 25,000 outstanding shares and a 100 percent payout policy. The expected value of the firm one year from now is $1,725,000. The appropriate discount rate for the company is 12 percent, and th
> Dorman Industries has a new project available that requires an initial investment of $4.3 million. The project will provide unlevered cash flows of $710,000 per year for the next 20 years. The company will finance the project with a debt-to-value ratio o
> In the previous problem, suppose the project requires an initial investment in net working capital of $285,000 and the fixed asset will have a market value of $225,000 at the end of the project. What is the project’s Year 0 net cash flow? Year 1? Year 2?
> Explain the following limits on the prices of warrants: a. If the stock price is below the exercise price of the warrant, the lower bound on the price of a warrant is zero. b. If the stock price is above the exercise price of the warrant, the lower bound
> Suppose your company needs $35 million to build a new assembly line. Your target debt–equity ratio is .75. The flotation cost for new equity is 6 percent, but the flotation cost for debt is only 2 percent. Your boss has decided to fund the project by bor
> Lohn Corporation is expected to pay the following dividends over the next four years: $13, $8, $6.50, and $2.40. Afterwards, the company pledges to maintain a constant 4.5 percent growth rate in dividends forever. If the required return on the stock is 1
> It is said that the equity holders of a levered firm can be thought of as holding a call option on the firm’s assets. Explain what is meant by this statement.
> If interest rates fall, will the price of noncallable bonds move up higher than that of callable bonds? Why or why not?
> A hundred years ago or so, companies did not compile annual reports. Even if you owned stock in a particular company, you were unlikely to be allowed to see the balance sheet and income statement for the company. Assuming the market is semistrong form ef
> It is sometimes stated that “the net present value approach assumes reinvestment of the intermediate cash flows at the required return.” Is this claim correct? To answer, suppose you calculate the NPV of a project in the usual way. Next, suppose you do t
> Take a look back at Figure 8.4(given below). Notice the wide range of coupon rates. Why are they so different? Treasury Notes & Bonds Asked Maturity 1/31/2015 2/15/2016 3/15/2017 3/31/2018 5/15/2019 8/15/2020 6/30/2021 11/15/2022 5/15/2023 11/15/202
> Cutler Petroleum, Inc., is trying to evaluate a generation project with the following cash flows: a. If the company requires a 10 percent return on its investments, should it accept this project? Why? b. Compute the IRR for this project. How many IRRs
> Shadow Corp. has no debt but can borrow at 6.5 percent. The firm’s WACC is currently 9.8 percent, and the tax rate is 35 percent. a. What is the company’s cost of equity? b. If the company converts to 25 percent debt, what will its cost of equity be? c.
> Hannon Home Products, Inc., recently issued $2 million worth of 3 percent convertible debentures. Each convertible bond has a face value of $1,000. Each convertible bond can be converted into 23.50 shares of common stock any time before maturity. The sto
> An all-equity firm is considering the following projects: The T-bill rate is 3.5 percent, and the expected return on the market is 11 percent. a. Which projects have a higher expected return than the firm’s 11 percent cost of capital?
> Complete the following sentence for each of these investors: a. A buyer of call options. b. A buyer of put options. c. A seller (writer) of call options. d. A seller (writer) of put options. “The (buyer/seller) of a (put/call) option (pays/receives) mone
> A stock has an expected return of 13.4 percent, the risk-free rate is 3.8 percent, and the market risk premium is 7 percent. What must the beta of this stock be?
> You purchased a zero coupon bond one year ago for $160.53. The market interest rate is now 7.5 percent. If the bond had 25 years to maturity when you originally purchased it, what was your total return for the past year?
> You are considering a new product launch. The project will cost $760,000, have a four-year life, and have no salvage value; depreciation is straight-line to zero. Sales are projected at 420 units per year; price per unit will be $17,200; variable cost pe
> Suppose in the previous problem that HISC always needs a conveyor belt system; when one wears out, it must be replaced. Which system should the firm choose now?
> The capital structure of Ricketti Enterprises, Inc., consists of 25 million shares of common stock and 1.5 million warrants. Each warrant gives its owner the right to purchase one share of common stock for an exercise price of $27. The current stock pric
> You own a lot in Key West, Florida, that is currently unused. Similar lots have recently sold for $1.3 million. Over the past five years, the price of land in the area has increased 12 percent per year, with an annual standard deviation of 30 percent. A
> An asset costs $720,000 and will be depreciated in a straight-line manner over its three-year life. It will have no salvage value. The corporate tax rate is 34 percent, and the appropriate interest rate is 10 percent. a. What set of lease payments will m
> A company’s stock currently sells for $73 per share. Last week the firm issued rights to raise new equity. To purchase a new share, a stockholder must remit $14 and three rights. a. What is the ex-rights stock price? b. What is the price of one right? c.
> The Webber Company is an international conglomerate with a real estate division that owns the right to erect an office building on a parcel of land in downtown Sacramento over the next year. This building would cost $55 million to construct. Due to low d
> Flychucker Corporation is evaluating an extra dividend versus a share repurchase. In either case $6,300 would be spent. Current earnings are $2.60 per share, and the stock currently sells for $51 per share. There are 1,500 shares outstanding. Ignore taxe
> Neon Corporation’s stock returns have a covariance with the market portfolio of .0415. The standard deviation of the returns on the market portfolio is 20 percent, and the expected market risk premium is 7.5 percent. The company has bonds outstanding wit
> Why are the costs of selling equity so much larger than the costs of selling debt?
> Bucksnort, Inc., has an odd dividend policy. The company has just paid a dividend of $9 per share and has announced that it will increase the dividend by $4 per share for each of the next five years, and then never pay another dividend. If you require a
> An insurance policy is considered analogous to an option. From the policyholder’s point of view, what type of option is an insurance policy? Why?
> Megabucks Industries is planning to raise fresh equity capital by selling a large new issue of common stock. Megabucks, a publicly traded corporation, is trying to choose between an underwritten cash offer and a rights offering (not underwritten) to curr
> The growing perpetuity model expresses the value of a share of stock as the present value of the expected dividends from that stock. How can you conclude that dividend policy is irrelevant when this model is valid?
> Do you agree or disagree with the following statement: In an efficient market, callable and noncallable bonds will be priced in such a way that there will be no advantage or disadvantage to the call provision. Why?
> In the middle to late 1990s, the performance of the pros was unusually poor—on the order of 90 percent of all equity mutual funds underperformed a passively managed index fund. How does this bear on the issue of market efficiency?
> One of the less flattering interpretations of the acronym MIRR is “meaningless internal rate of return.” Why do you think this term is applied to MIRR?
> Gary Levin is the chief executive officer of Mountain Brook Trading Company. The board of directors has just granted Mr. Levin 25,000 at-the-money European call options on the company’s stock, which is currently trading at $55 per share. The stock pays n
> In 2003, Porsche unveiled its new sports utility vehicle (SUV), the Cayenne. With a price tag of over $40,000, the Cayenne goes from zero to 62 mph in 8.5 seconds. Porsche’s decision to enter the SUV market was in response to the runaway success of other
> What is the impact of an increase in the volatility of the underlying stock’s return on an option’s value? Explain.
> 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
> Do you agree or disagree with the following statement? A firm’s stockholders will never want the firm to invest in projects with negative net present values. Why?
> What are the implications for bond investors of the lack of transparency in the bond market?
> The Cori’s Sausage Corporation is trying to choose between the following two mutually exclusive design projects: a. If the required return is 10 percent and the company applies the profitability index decision rule, which project shou
> Titan Mining Corporation has 8.7 million shares of common stock outstanding and 230,000 6.4 percent semiannual bonds outstanding, par value $1,000each. The common stock currently sells for $37 per share and has a beta of 1.20, and the bonds have 20 years
> A stock has had returns of 14.38 percent, 8.43 percent, 11.97 percent, 25.83 percent, and −9.17 percent over the past five years, respectively. What was the holding period return for the stock?
> Consider a four-year project with the following information: Initial fixed asset investment 5 $410,000; straight-line depreciation to zero over the four-year life; zero salvage value; price 5 $35; variable costs 5 $23; fixed costs 5 $176,000; quantity so
> The price of Ervin Corp. stock will be either $53 or $67 at the end of the year. Call options are available with one year to expiration. T-bills currently yield 5 percent. a. Suppose the current price of the stock is $58. What is the value of the call op
> Hagar Industrial Systems Company (HISC) is trying to decide between two different conveyor belt systems. System A costs $290,000, has a four-year life, and requires $89,000 in pretax annual operating costs. System B costs $410,000, has a six-year life, a
> Bauble, Inc., an all-equity firm, has eight shares of stock outstanding. Yesterday, the firm’s assets consisted of nine ounces of platinum, currently worth $1,650 per ounce. Today, the company issued Ms. Wu a warrant for its fair value of $1,650. The war
> What are the deltas of a call option and a put option with the following characteristics? What does the delta of the option tell you? Stock price = $76 %3D Exercise price = $70 %3D Risk-free rate = 5% per year, compounded continuously Maturity = 9 m
> Monster Magnet Manufacturing is considering leasing some equipment. The annual lease payment would be $295,000 per year for six years. The appropriate interest rate is 7 percent and the company is in the 38 percent tax bracket. How would signing the leas
> In a world with no taxes, no transaction costs, and no costs of financial distress, is the following statement true, false, or uncertain? If a firm issues equity to repurchase some of its debt, the price per share of the firm’s stock will rise because th
> What are the main features of a corporate bond that would be listed in the indenture?
> In the previous problem, what would the ROE on the investment have to be if we wanted the price after the offering to be $75 per share? (Assume the PE ratio remains constant.) What is the NPV of this investment? Does any dilution take place?
> In the previous problem, suppose you want only $500 total in dividends the first year. What will your homemade dividend be in two years?
> MVP, Inc., has produced rodeo supplies for over 20 years. The company currently has a debt–equity ratio of 50 percent and is in the 40 percent tax bracket. The required return on the firm’s levered equity is 16 percent
> Weston Industries has a debt–equity ratio of 1.5. Its WACC is 10.5 percent, and its cost of debt is 6 percent. The corporate tax rate is 35 percent. a. What is the company’s cost of equity capital? b. What is the company’s unlevered cost of equity capita
> You work for a nuclear research laboratory that is contemplating leasing a diagnostic scanner (leasing is a common practice with expensive, high-tech equipment). The scanner costs $5,800,000, and it would be depreciated straight-line to zero over four ye
> The following Treasury bond quote appeared in The Wall Street Journal on May 11, 2004: Why would anyone buy this Treasury bond with a negative yield to maturity? How is this possible? 9.125 May 09 100.09375 100.12500 -2.15 ...
> Metallica Bearings, Inc., is a young start-up company. No dividends will be paid on the stock over the next nine years, because the firm needs to plow back its earnings to fuel growth. The company will pay a dividend of $17.50 per share in 10 years and w
> What are the possible reasons why the stock price typically drops on the announcement of a seasoned new equity issue?
> Several publicly traded companies have issued more than one class of stock. Why might a company issue more than one class of stock?
> Technical analysis is a controversial investment practice. Technical analysis covers a wide array of techniques, which are all used in an attempt to predict the direction of a particular stock or the market. Technical analysts look at two major types of
> You are evaluating Project A and Project B. Project A has a short period of future cash flows, while Project B has relatively long future cash flows. Which project will be more sensitive to changes in the required return? Why?
> What are the differences between preferred stock and debt?
> In 2003, Porsche unveiled its new sports utility vehicle (SUV), the Cayenne. With a price tag of over $40,000, the Cayenne goes from zero to 62 mph in 8.5 seconds. Porsche’s decision to enter the SUV market was in response to the runaway success of other
> 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
> Historically, the U.S. tax code treated dividend payments made to shareholders as ordinary income. Thus, dividends were taxed at the investor’s marginal tax rate, which was as high as 38.6 percent in 2002. Capital gains were taxed at a capital gains tax
> The Woods Co. and the Garcia Co. have both announced IPOs at $40 per share. One of these is undervalued by $11, and the other is overvalued by $3, but you have no way of knowing which is which. You plan on buying 1,000 shares of each issue. If an issue i
> What factors influence a firm’s choice of external versus internal equity financing?
> Technical analysis is a controversial investment practice. Technical analysis covers a wide array of techniques, which are all used in an attempt to predict the direction of a particular stock or the market. Technical analysts look at two major types of
> Consider the following cash flows on two mutually exclusive projects for the Bahamas Recreation Corporation (BRC). Both projects require an annual return of 14 percent. As a financial analyst for BRC, you are asked the following questions: a. If your d
> You own a portfolio equally invested in a risk-free asset and two stocks. If one of the stocks has a beta of 1.73 and the total portfolio is equally as risky as the market, what must the beta be for the other stock in your portfolio?
> Given the information in Problem 10, what was the average real risk-free rate over this time period? What was the average real risk premium?
> Consider a project with a required return of R percent that costs $I and will last for N years. The project uses straight-line depreciation to zero over the N-year life; there are neither salvage value nor net working capital requirements. a. At the acco
> Massey Machine Shop is considering a four-year project to improve its production efficiency. Buying a new machine press for $730,000 is estimated to result in $270,000 in annual pretax cost savings. The press falls in the MACRS five- year class, and it w
> Define the three forms of market efficiency.
> Rob Stevens is the chief executive officer of Isner Construction, Inc., and owns 850,000 shares of stock. The company currently has 5.1 million shares of stock and convertible bonds with a face value of $40 million outstanding. The convertible bonds have
> What are the prices of a call option and a put option with the following characteristics? Stock price = $93 Exercise price = $90 Risk-free rate = 4% per year, compounded continuously Maturity = 5 months Standard deviation = 53% per year
> Roll Corporation (RC) currently has 465,000 shares of stock outstanding that sell for $73 per share. Assuming no market imperfections or tax effects exist, what will the share price be after: a. RC has a five-for-three stock split? b. RC has a 15 percent
> 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 all-equity firm Metallica Heavy Metal Mining (MHMM) Corporation wants to diversify its operations. Some recent financial information for the company is shown here: MHMM is considering an investment that has the same PE ratio as the firm. The cost o
> You own 1,000 shares of stock in Avondale Corporation. You will receive a dividend of $2.60 per share in one year. In two years, Avondale will pay a liquidating dividend of $53 per share. The required return on Avondale stock is 14 percent. What is the c
> For the company in the previous problem, what is the value of being able to issue subsidized debt instead of having to issue debt at the terms it would normally receive? Assume the face amount and maturity of the debt issue are the same.
> In the previous question, suppose the corporate tax rate is 35 percent. What is EBIT in this case? What is the WACC? Explain.
> Williams Industries has decided to borrow money by issuing perpetual bonds with a coupon rate of 6.5 percent, payable annually. The one-year interest rate is 6.5 percent. Next year, there is a 35 percent probability that interest rates will increase to 8
> Given the following information for Huntington Power Co., find the WACC. Assume the company’s tax rate is 35 percent. Debt: 10,000 5.6 percent coupon bonds outstanding, $1,000 par value, 25 years to maturity, selling for 97 percent of par; the bonds make
> Universal Laser, Inc., just paid a dividend of $2.90 on its stock. The growth rate in dividends is expected to be a constant 6 percent per year, indefinitely. Investors require a 15 percent return on the stock for the first three years, a 13 percent retu
> Which of the following should be treated as an incremental cash flow when computing the NPV of an investment? a. A reduction in the sales of a company’s other products caused by the investment. b. An expenditure on plant and equipment that has not yet be
> What is the impact of lengthening the time to expiration on an option’s value? Explain.
> If Wild Widgets, Inc., were an all-equity company, it would have a beta of .95. The company has a target debt–equity ratio of .40. The expected return on the market portfolio is 11 percent, and Treasury bills currently yield 4 percent. The company has on
> The shareholders of Bryant Power Corp. need to elect three new directors to the board. There are 16,500,000 shares of common stock outstanding, and the current share price is $13.75. If the company uses cumulative voting procedures, how much will it cost