Question: JC Automobiles is a small auto parts

> You have been asked to estimate a Markowitz portfolio across a universe of 1,250 assets. a. How many expected returns and variances would you need to compute? b. How many covariances would you need to compute to obtain Markowitz portfolios?  

> Novell, which had a market value of equity of $2 billion and a beta of 1.50, announced that it was acquiring Word- Perfect, which had a market value of equity of $1 billion and a beta of 1.30. Neither firm had any debt in its financial structure at the t

> Tech Products reported a net loss of $80 million for the latest financial year. In addition, the firm reported a net capital expenditure of $70 million and a change in non- cash working capital of $10 million. Finally, the firm had $10 million in debt at

> Zycor Corporation obtains most of its funding internally. Assume that the stock has a beta of 1.2, the riskless rate is 6.5%, and the market risk premium is 6%. a. Estimate the cost of internal equity. b. Now assume that the cost of issuing new stock is

> Safecorp, which owns and operates grocery stores across the United States, currently has $50 million in debt and $100 million in equity outstanding. Its stock has a beta of 1.2. It is planning a leveraged buyout, where it will increase its debt-to-equity

> You have just been approached by a magazine with an offer for renewing your subscription. You can renew for one year at $20, two years for $36, or three years at $45. Assuming that you have an opportunity cost of 20% and the cost of a subscription will n

> You are trying to choose a new siding for your house. A salesman offers you two choices: a. Wood siding, which will last 10 years and cost $5,000to install and $1,000/year to maintain. b. Aluminum siding, which will last forever, cost $15,000 to install,

> The following table lists returns on the market portfolio and on Microsoft, each year from 1989 to 1998. a. Estimate the covariance in returns between Microsoft and the market portfolio. b. Estimate the variances in returns on both investments. c. Estima

> Upjohn, also a major pharmaceutical company, is considering increasing its debt ratio from 11% to 40%, which is its optimal debt ratio. Its beta is 1.17, and the current Treasury bond rate is 6.50%. The return on equity was 14.5% in the most recent year,

> You have been asked to analyze the capital structure of DASA, an environmental waste disposal firm, and make recommendations on a future course of action. DASA has 40 million shares outstanding, selling at $20 per share, and a debt/equity ratio (in marke

> The unlevered beta of electronics firms, on average, is 1.1. The riskless rate is 6.5%, and the market risk premium is 6%. a. Estimate the expected return, using the CAPM. b. If you are a venture capitalist, why might you have a target rate of return muc

> You have been asked to compare three alternative investments and make a recommendation. • Project A has an initial investment of $5 million and after-tax cash flows of $2.5 million a year for the next five years. • Project B has no initial investment, af

> You are analyzing two mutually exclusive projects with the following cash flows: a. Estimate the NPV of each project, assuming a cost of capital of 10%. Which is the better project? b. Estimate the IRR for each project. Which is the better project? c. Wh

> Every investor in the capital asset pricing model owns a combination of the market portfolio and a riskless asset. Assume that the standard deviation of the market portfolio is 30% and that the expected return on the portfolio is 15%. What proportion of

> In Germany, large banks are often large lenders and large equity investors in the same firm. For instance, Deutsche Bank is the largest stockholder in Daimler Chrysler, as well as its largest lender. What are some of the potential conflicts that you see

> A prominent beta estimation service reports the beta of Comcast Corporation, a major cable TV operator, to be 1.45. The service claims to use weekly returns on the stock over the prior five years and the NYSE composite as the market index to estimate bet

> In the face of disappointing earnings results and increasingly assertive institutional stockholders, Eastman Kodak was considering the sale of its health division, which earned $560 million in EBIT in the most recent year on revenues of $5.285 billion. T

> RJR Nabisco, in response to stockholder pressure in 1996, announced a significant increase in dividends paid to stockholders financed by the sale of some of its assets. What would you expect the stock price to do? Why?

> Stock buybacks really do not return cash to stockholders because only those who sell back stock receive the cash. Is this statement true or false? Explain.

> Pfizer, a major pharmaceutical company, has a debt ratio of 10.30% and is considering increasing its debt ratio to 30%. Its cost of capital is expected to drop from 14.51% to 13.45%. Pfizer had an EBIT of $2 billion in 1995 and a book value of capital (d

> Terck, a leading pharmaceutical company, currently has a balance sheet that is as follows: The firm’s income statement looks as follows: The firm’s bonds are all 20-year bonds with a coupon rate of 10% that are selling

> You are a venture capitalist and have been approached by Cirrus Electronics, a private firm. The firm has no debt outstanding and does not have earnings now but is expected to be earning $15 million in four years, when you also expect it to go public. Th

> Estimate the MIRR for the project described in Problem 8. Does it change your decision on accepting this project?

> Reader’s Digest has voting and nonvoting shares. About 70% of the voting shares are held by charitable institutions, which are headed by the CEO of Reader’s Digest. Assume that you are a large holder of the nonvoting shares. Would you be concerned about

> New Age Telecomm is a young, high-growth telecommunications firm. It pays no dividends, although the average dividend payout for other firms in the telecommunications sector is 40%. Is New Age paying too little in dividends? Why or why not?

> Lockheed, one of the largest defense contractors in the United States, reported EBITDA of $1,290 million in a recent financial year, prior to interest expenses of $215 million and depreciation charges of $400 million. Capital expenditures amounted to $45

> WeeMart, a retailer of children’s clothes, announces a cut in dividends following a year in which both revenues and earnings dropped significantly. How would you expect its stock price to react? Explain.

> Assuming that you do the analysis in Problem 8 with both firm value and operating income, what are the reasons for the differences you might find in the results, using each? When would you use one over the other.

> You have been called in as a consultant for Herbert’s a sporting goods retail firm, which is examining its debt policy. The firm currently has a balance sheet as follows: The firm’s income statement is as follows: The

> Vernon Enterprises has current after-tax operating income of $100 million and a cost of capital of 10%. The firm earns a return on capital equal to its cost of capital. a. Assume that the firm is in stable growth, growing 5% a year forever; estimate the

> Assume now that Office Helpers decides to go public and would like to offer its shares at a target price of $10 per share. If the IPO is likely to be underpriced by 20%, how many shares should the firm have?

> The lining of a plating tank must be replaced every three years at the cost of approximately $2,000. A new lining material has been developed that is more resistant to the corrosive effects of the plating liquid and will cost approximately $4,000. If the

> You have estimated the following cash flows on a project: Plot the NPV profile for this project. What is the IRR? If the cost of equity is 16%, would you accept this project? Year Cash Flow to Equity (S) -5,000,000 4,000,000 1 2 4,000,000 3 -3,000,00

> The following table summarizes the percentage changes in operating income, percentage changes in revenue, and betas for four pharmaceutical firms. a. Calculate the degree of operating leverage for each of these firms. b. Use the operating leverage to exp

> Assume that the average variance of return for an individual security is 50% and that the average covariance is 10%. What is the expected variance of a portfolio of 5, 10, 20, 50, and 100 securities. How many securities need to be held before the risk of

> In recent years, top managers have been given large packages of options, giving them the right to buy stock in the firm at a fixed price. Will these compensation schemes make managers more responsive to stockholders? Why or why not? Are lenders to the fi

> Would your answer be different for the previous problem if JC Automobiles were a large firm followed by thirty-five analysts? Why or why not?

> Tech Products, from Question 7, pays a dividend of $40 million. Assuming that the firm started the period with no cash, how did it raise the funding for the dividend payment?

> Union Pacific Railroad reported net income of $770 million after interest expenses of $320 million in a recent financial year. (The corporate tax rate was 36%.) It reported depreciation of $960 million in that year, and capital spending was $1.2 billion.

> Repeat the analysis in Problem 7 for a private firm that has provided you with the following estimates of operating income for the 10 years, for which you have the macroeconomic data: Operating Income Year (in dollars thousands) 1985 463.05 1986 411.

> BMD is a firm with no debt on its books currently anda market value of equity of $2 billion. On the basis of its EBITDA of $200 million, it can afford to have a debt ratio of 50%, at which level the firm value should be $300 million higher. a. Assuming t

> GenCorp, an automotive parts manufacturer, currently has $25 million in outstanding debt and has 10 million shares outstanding. The book value per share is $10, and the market price per share is $25. The company is currently rated A, its bonds have a yie

> Office Helpers is a private firm that manufactures and sells office supplies. The firm has limited capital and is estimated to have a value of $80 million with the capital constraints. A venture capitalist is willing to contribute $20 million to the firm

> You are helping a bookstore decide whether it should open a coffee shop on the premises. The details of the investment are as follows: • The coffee shop will cost $50,000 to open; it will have a five-year life and be depreciated straight line over the pe

> You are provided with the following cash flows on a project: Plot the net present value (NPV) profile for this project. What is the IRR? If this firm had a cost of capital of 10% and a cost of equity of 15%, would you accept this project? Year Operat

> You are analyzing the beta for Hewlett Packard and have broken down the company into four broad business groups, with market values and betas for each group. a. Estimate the beta for Hewlett Packard as a company. Is this beta going to be equal to the bet

> Consider the project described in Problem 6. Assume that the firm plans to finance 40% of its net capital expenditure and working capital needs with debt. a. Estimate the cash flow to equity for each of the four years. b. Estimate the payback period for

> Companies outside the United States often have two classes of stock outstanding. One class of shares is voting and is held by the incumbent managers of the firm. The other class is nonvoting and represents the bulk of traded shares. What are the conseque

> Now assume that Gemco Jewelers has $10 million in cash and non-operating assets and that the firm has $15 million in outstanding debt. a. Estimate the value of equity in the firm. b. If the firm has 5 million shares outstanding, estimate the value of equ

> You are attempting to structure a debt issue for Eaton Corporation, a manufacturer of automotive components. You have collected the following information on the market values of debt and equity for the past 10 years: In addition, you have the following i

> Plastico, a manufacturer of consumer plastic products, is evaluating its capital structure. The balance sheet of the company is as follows (in millions): In addition, you are provided the following information: • The debt is in the form

> UB is examining its capital structure with the intent of arriving at an optimal debt ratio. It currently has no debt and has a beta of 1.5. The riskless interest rate is 9%. Your research indicates that the debt rating will be as follows at different deb

> You are considering the possibility of replacing an existing machine that has a book value of $500,000, a remaining depreciable life of five years, and a salvage value of $300,000. The replacement machine will cost $2 million and have a 10-year life. Ass

> Antitakeover amendments can be in the best interests of stockholders. Under what conditions is this likely to be true?

> Geotech Inc., which has had a history of high growth and pays no dividends, announces that it will start paying dividends next quarter. How would you expect its stock price to react to the announcement? Why?

> Gemco Jewelers earned $5 million in after-tax operating income in the most recent year. The firm also had capital expenditures of $4 million and depreciation of $2 million during the year, and the noncash working capital at the end of the year was $10 mi

> Now assume that Lube Oil has a return on equity of 5% and a cost of equity of 10%. As a stockholder in Lube Oil, would you want the firm to change its dividend policy? Why or why not?

> Assume now that you have uncovered the following facts about the types of projects STL takes: • The projects are primarily infrastructure projects, requiring large initial investments and long gestation periods. • Most of the new projects will be in emer

> You have been hired as a management consultant by AD Corporation to evaluate whether it has an appropriate amount of debt (the company is worried about a leveraged buyout). You have collected the following information on AD’s current po

> You have been asked to estimate the debt ratio for a firm with the following financing details: • The firm has two classes of shares outstanding: 50,000 shares of class A stock, with 2 voting rights per share, trading at $100 per share, and 100,000 share

> You have been hired as a capital budgeting analyst by a sporting goods firm that manufactures athletic shoes and has captured 10% of the overall shoe market (the total market is worth $100 million a year). The fixed costs associated with manufacturing th

> An income bondholder receives interest payments only if the firm makes income. If the firm does not make interest payments in a year, the interest is cumulated and paid in the first year the firm makes income. A preferred stock receives preferred dividen

> You are provided with the projected income statements for a project: • The tax rate is 40%. • The project required an initial investment of $15,000and an additional investment of $2,000 at the end of year 2. â&#1

> Assume that you have half of your money invested in Times Mirror, the media company, and the other half invested in Unilever, the consumer product giant. The expected returns and standard deviations on the two investments are summarized below: Estimate t

> You are interested in creating a portfolio of two stocks—Coca Cola and Texas Utilities. Over the last decade, an investment in Coca Cola stock would have earned an average annual return of 25%, with a standard deviation in returns of 36%. An investment i

> There are some corporate strategists who have suggested that firms focus on maximizing market share rather than market prices. When might this strategy work, and when might it fail?

> How would your answers to the last two questions change if you were told that Lube Oil started the year with $120 million in debt and ended the year with $135 million?

> UJ Gas is a utility that has followed a policy of increasing dividends every quarter by 5% over dividends in the prior year. The company announces that it will increase quarterly dividends from $1.00 to $1.02 next quarter. What price reaction would you e

> Under what conditions will the return on equity on a project be equal to the IRR, estimated from cash flows to equity investors, on the same project?

> Netsoft is a company that manufactures networking software. In the current year, the firm reported operating earnings before interest and taxes of $200 million (operating earnings does not include interest income), and these earnings are expected to grow

> STL has asked you for advice on putting together the details of the new debt issues it is planning to make. What information would you need to obtain to provide this advice?

> As CEO of a major corporation, you have to make a decision on how much you can afford to borrow. You currently have 10 million shares outstanding, and the market price per share is $50. You also currently have about $200 million in debt outstanding (mark

> A small manufacturing firm, which has limited access to capital, has a capital rationing constraint of $150 million and is faced with the following investment projects(numbers in millions): a. Which of these projects would you accept? Why? b. What is the

> You have been asked to calculate the debt ratio for a firm that has the following components to its financing mix: • The firm has 1 million shares outstanding, trading at $50 per share. • The firm has $25 million in straight debt, carrying a market inter

> You have just done a regression of monthly stock re- turns of HeavyTech, a manufacturer of heavy machinery, on monthly market returns over the past five years and come up with the following regression: The standard deviation of the stock is 50%, and the

> Maximizing stock prices does not make sense because investors focus on short-term results and not on the long-term consequences. Comment.

> You are analyzing a convertible preferred stock with the following characteristics for the security: • There are 50,000 preferred shares outstanding, with a face value of $100 and a 6% preferred dividend rate. • The firm has straight preferred stock outs

> Lube Oil, in Question 3, paid a dividend of $20 million and bought back $25 million in stock. Estimate how much the cash balance of the firm changed during the year.

> Cell Phone is a cellular firm that reported net income of $50 million in the most recent financial year. The firm had $1 billion in debt, on which it reported interest expenses of $100 million in the most recent financial year. The firm had depreciation

> DGF Corporation has come to you for some advice on how best to increase their leverage over time. In the most recent year, DGF had an EBITDA of $300 million, owed $1 billion in both book value and market value terms and had a net worth of $2 billion (the

> Plastico is interested in how it compares with its competitors in the same industry. a. Taking each of these variables, explain at an intuitive level whether you would expect Plastico to have more or less debt than its competitors and why. b. You have al

> Answer true or false to the following statements: a. The return on equity for a project will always be higher than the return on capital on the same project. b. If the return on capital is less than the cost of equity, the project should be rejected. c.

> Genting Berhad is a Malaysian conglomerate with holdings in plantations and tourist resorts. The beta estimated for the firm, relative to the Malaysian stock exchange, is 1.15, and the long-term local currency risk free rate in Malaysia is 11.5%. a. Esti

> You have been given the following information on a project: • It has a five-year lifetime • The initial investment in the project will be $25 million, and the investment will be depreciated straight line, down to a salvage value of $10 million at the end

> You are in a world where there are only two assets, gold and stocks. You are interested in investing your money in one, the other, or both assets. Consequently, you collect the following data on the returns on the two assets over the last six years. a.

> Stock prices are much too volatile for financial markets to be efficient. Comment.

> IOU has $5 billion in debt outstanding (carrying an interest rate of 9%) and 10 million shares trading at $50 per share. Based on its current EBIT of $200 million, its optimal debt ratio is only 30%. The firm has a beta of 1.20, and the current Treasury

> Plastico is considering a major change in its capital structure. It has three options: • Option 1: Issue $1 billion in new stock and repurchase half of its outstanding debt. This will make it an AAA-rated firm (AAA rated debt is yielding 11% in the marke

> You are analyzing a new security that has been promoted as equity, with the following features: • The dividend on the security is fixed in dollar terms for the life of the security, which is 20 years. • The dividend is not tax-deductible. • In the case o

> You own a rental building in the city and are interested in replacing the heating system. You are faced with the following alternatives: a. A solar heating system, which will cost $12,000 to install and $500 a year to run and will last forever (assume th

> Consider again the project described in Problem 1 (assume that the depreciation reverts to a straight line). Assume that 40% of the initial investment for the project will be financed with debt, with an annual interest rate of 10% and a balloon payment o

> Biogen, a biotechnology firm, had a beta of 1.70 in 1995. It had no debt outstanding at the end of that year. a. Estimate the cost of equity for Biogen, if the Treasury bond rate is 6.4%. b. What effect will an increase in long-term bond rates to 7.5% ha

> The following table summarizes the annual returns you would have made on two companies—Scientific Atlanta, a satellite and data equipment manufacturer, and AT&T, the telecomm giant, from 1988 to 1998. a. Estimate the average and sta

> Stockholders can transfer wealth from bondholders through a variety of actions. How would the following actions by stockholders transfer wealth from bondholders? a. An increase in dividends b. A leveraged buyout c. Acquiring a risky business How would bo

> In December 1995, Boise Cascade’s stock had a beta of 0.95. The Treasury bill rate at the time was 5.8%, and the Treasury bond rate was 6.4%. The firm had debt out- standing of $1.7 billion and a market value of equity of $1.5 billion; the corporate marg

> Consolidated Power is a regulated electric utility that has equity with a market value of $1.5 billion and debt outstanding of $3 billion. A consultant notes that this is a high debt ratio relative to the average across all firms, which is 27%, and sugge

> Unitrode, which makes analog/linear integrated circuits for power management, is a firm that has not used debt in the financing of its projects. The managers of the firm contend that they do not borrow money because they want to maintain financial flexib

> XYZ Pharma is a pharmaceutical company that traditionally has not used debt to finance its projects. Over the past 10 years, it has also reported high returns on its projects and growth and made substantial research and development expenses over the time

> Handy and Harman, a leading fabricator of precious metal alloys, pays out only 23% of its earnings as dividends. The average dividend payout ratio for metal fabricating firms is 45%. The average growth rate in earnings for the entire sector is 10% (Handy

> Assume that personal investors pay a 40% tax rate on interest income and only a 20% tax rate on equity income. If the corporate tax rate is 30%, estimate whether debt has a tax benefit, relative to equity. If a firm with no debt and $100 million in marke