Question: Management of March and Dine Inc. has

> You are working as an intern at Coral Gables Products, a privately owned manufacturing company. Shortly after you read Chapter 13 in this book, you got into a discussion with the Chief Financial Officer (CFO) at Coral Gables about weighted average cost o

> Why does the market value of the claims on the assets of a firm equal the market value of the assets?

> Hurricane Corporation is financed with debt, preferred equity, and common equity with market values of $20 million, $10 million, and $30 million, respectively. The betas for the debt, preferred stock, and common stock are 0.2, 0.5, and 1.1, respectively.

> Discuss what valuable information would be lost if you decided to use book values in order to calculate the cost of each of the capital components within a firm’s capital structure?

> Enigma Corporation’s management believes that the firm’s cost of capital (WACC) is too high because the firm has been too secretive with the market concerning its operations. Evaluate that statement?

> RetRyder Hand Trucks has a preferred share issue outstanding that pays a dividend of $1.30 per year. The current cost of preferred equity for RetRyder is 9 percent. If RetRyder issues additional preferred shares that pay exactly the same dividend and the

> In your analysis of the cost of capital for a common stock, you calculate a cost of capital using a dividend discount model that is much lower than the calculation for the cost of capital using the CAPM model. Explain a possible source for the discrepanc

> How are taxes accounted for when we calculate the cost of debt?

> You are an external financial analyst evaluating the merits of a stock. Since you are using a dividend discount model approach to evaluate a cost of equity capital, you need to estimate the dividend growth rate for the firm in the future. Describe how yo

> You are analyzing the cost of capital for MacroSwift Corporation, which develops software operating systems for computers. The firm’s dividend growth rate has been a very constant 3 percent per year for the past 15 years. Competition for the firm’s curre

> If a firm’s management anticipates financing a project with a capital mix that is different from its current capital structure, describe how the firm is subjecting itself to a calculation error if its historical WACC is used to evaluate the project?

> For the Imaginary Products firm in Problem 13.24, calculate the appropriate cost of capital for a new project that is financed with the same proportion of debt, preferred shares, and common shares as the firm’s current capital structure. Also assume that

> How does a scenario analysis differ from a sensitivity analysis?

> The Imaginary Products Co. currently has debt with a market value of $300 million outstanding. The debt consists of 9 percent coupon bonds (semiannual coupon payments) which have a maturity of 15 years and are currently priced at $1,440.03 per bond. The

> The managers of a firm financed entirely with common stock are evaluating two distinct projects. The first project has a large amount of unsystematic risk and a small amount of systematic risk. The second project has a small amount of unsystematic risk a

> You have calculated the cost of common stock using all three methods described in this chapter. Unfortunately, all three methods have yielded different answers. Describe which answer (if any) is most appropriate?

> Write out the general equation for the price of the stock for a firm that will grow dividends very rapidly at a constant rate for the four years after the next dividend is paid and will grow dividends thereafter at a constant, but lower rate. Discuss the

> Underestimated Inc.’s common shares currently sell for $36 each. The firm’s management believes that its shares should really sell for $54 each. If the firm just paid an annual dividend of $2 per share and management expects those dividends to increase b

> What is the weighted average cost of capital for a firm?

> You are analyzing the after-tax cost of debt for a firm. You know that the firm’s 12-year maturity, 9.5 percent semiannual coupon bonds are selling at a price of $1,200. If these bonds are the only debt outstanding for the firm, what is the after-tax cos

> Holding all other things constant, does a decrease in the marginal tax rate for a firm provide incentive for the managers of a firm to increase or decrease its use of debt?

> You are analyzing the cost of debt for a firm. You know that the firm’s 14-year maturity, 8.5 percent coupon bonds are selling at a price of $823.48. The bonds pay interest semiannually. If these bonds are the only debt outstanding, what is the after-tax

> You know that the after-tax cost of debt capital for Bubbles Champagne Company is 7 percent. If the firm has only one issue of five-year bonds outstanding, what is the current price of the bonds if the coupon rate on those bonds is 10 percent? Assume the

> What is a simulation analysis, and what can it tell us?

> Explain why the cost of capital for a firm is equal to the expected rate of return to the investors in the firm?

> Explain why the total value of all of the securities used to finance a firm must be equal to the value of the firm?

> Describe the alternatives to using a firm’s WACC as a discount rate when evaluating a project?

> KneeMan Markup Company has total debt obligations with book and market values equal to $30 million and $28 million, respectively. It also has total equity with book and market values equal to $20 million and $70 million, respectively. If you were going t

> Why is the per-unit contribution important in a break-even analysis?

> Caterpillar, Inc. is a manufacturer of large earth-moving and mining equipment. This firm, and other heavy equipment manufacturers, have accounting degrees of operating leverage that are relatively high. Explain why?

> The degree of pretax cash flow operating leverage at Rackit Corporation is 2.7 when it sells 100,000 units of its new tennis racket and its EBITDA is $95,000. Ignoring the effects of taxes, what are the fixed costs for Rackit Corporation?

> WalkAbout Kangaroo Shoe Stores forecasts that it will sell 9,500 pairs of shoes next year. The firm buys its shoes for $50 per pair from the wholesaler and sells them for $75 per pair. If the firm will incur fixed costs plus depreciation and amortization

> The Fulcrum Company produces decorative swivel platforms for home televisions. If Fulcrum produces 40 million units, it estimates that it can sell them for $100 each. The variable production costs are $65 per unit, whereas the fixed production costs are

> Commodore Motors management is considering a project to produce toy cars. The project would require an initial outlay of $100,000 and have an expected life of 10 years. Management estimates that each year during the life of the project depreciation and

> How is the per-unit contribution related to the accounting operating profit break-even point?

> You are the project manager for Eagle Golf Corporation. You are considering manufacturing a new golf wedge with a unique groove design. You have put together the estimates in the following table about the potential demand for the new club, and the asso

> Using the same logic as with the accounting break-even calculation in Problem 12.19, adapt the formula for crossover level of unit sales to find the number of units sold where the pretax operating cash flow is the same whether the firm chooses the large

> If a firm’s costs (both variable as well as fixed) are known with certainty, then what are the only two sources of volatility for the firm’s operating profits or its operating cash flows?

> Silver Polygon, Inc., has determined that if its revenues were to increase by 10 percent, then EBIT would increase by 25 percent to $100,000. The fixed costs (cash only) for the firm are $100,000. Given the same 10 percent increase in revenues, what woul

> If a firm has a fixed asset base, meaning that its depreciation and amortization for any year is positive, discuss the relation between its Accounting DOL and its Cash flow DOL?

> The Generic Publications Textbook Company sells all of its books for $100 per book, and it currently costs $50 in variable costs to produce each text. The fixed costs, which include depreciation and amortization for the firm, are currently $2 million per

> Mick’s Soft Lemonade is starting to develop a new product for which the cash fixed costs are expected to be $80,000. The projected EBIT is $100,000, and the Accounting DOL is expected to be 2.0. What is the Cash Flow DOL for the firm?

> If you were interested in calculating the probability that your project will have a positive FCF, what type of risk analysis tool will you most likely use?

> Chip’s Home Brew Whiskey management forecasts that if the firm sells each bottle of Snake-Bite for $20, then the demand for the product will be 15,000 bottles per year, whereas sales will be 90 percent as high if the price is raised 10 percent. Chip’s v

> Describe the circumstances under which sensitivity analysis might be a reasonable basis for determining changes to a firm’s EBIT or FCF?

> What is the difference between the pretax operating cash flow break-even point and the accounting operating profit break-even point?

> Sensitivity analysis and scenario analysis are somewhat similar. Describe which is a more realistic method of analyzing the impact of different scenarios on a project?

> The BowGus Archery Company management estimates that its new Galactically Flexible Bow project will have to generate EBIT of $20,000 each year to be viable. The project’s fixed cash expenses are expected to equal $8,000 and its depreciation and amortizat

> RoseWeiser Company Management is considering a project that will require an initial investment of $50,000 and will last for 10 years. No other capital expenditures or increases in working capital are anticipated during the life of the project. What is

> Your analysis tells you that at a projected level of sales, a project your firm is considering will be below accounting break-even but above cash flow break-even. Explain why this might still be a viable project for your firm?

> Calculate the pretax operating cash flow break-even point for both factory choices for Dandle’s Candles? Use the following information below: Dandle’s Candles will be producing a new line of dripless candles in the coming years and has the choice of pro

> Describe the role that the mix of variable versus fixed costs has in the variation of earnings before interest and taxes (EBIT) for the firm?

> Calculate the number of candles for which the accounting operating profit at Dandle's Candles is the same regardless of the factory choice? Use the following information below: Dandle’s Candles will be producing a new line of dripless candles in the com

> Calculate the accounting operating profit break-even point for both factory choices for Dandle’s Candles? Use the following information below: Dandle’s Candles will be producing a new line of dripless candles in the coming years and has the choice of pr

> For the Vinyl CD Co. in Self-Study Problem 12.3, what percentage increase in pretax operating cash flow will be driven by the additional revenue?

> What do the degree of pretax cash flow operating leverage (Cash Flow DOL) and the degree of accounting operating leverage (Accounting DOL) tell us?

> The pretax operating cash flow of Memphis Motors declined so much during the recession of 2008 and 2009 that the company almost defaulted on its debt. The owner of the company wants to change the cost structure of his business so that this does not happe

> Specialty Light Bulbs anticipates selling 3,000 light bulbs this year at a price of $15 per bulb. It costs Specialty $10 in variable costs to produce each light bulb, and the fixed costs for the firm are $10,000. Specialty has an opportunity to sell an a

> Duplicate Footballs, Inc., expects to sell 15,000 balls this year. The balls sell for $110 each and have a variable cost per unit of $80. Fixed costs, including depreciation and amortization, are currently $220,000 per year. How much can either the fixed

> What is simulation analysis, and how is it used?

> The accounting operating profit break-even point tells us the number of units that must be sold for a firm to break-even in a given year from an accounting operating profit perspective. What measure tells us the number of units that must be sold each yea

> Calculate the accounting operating profit break-even point and pretax operating cash flow break-even point for each of the three production choices outlined below?

> Define variable costs and fixed costs, and give an example of each?

> Zippy Corporation just purchased computing equipment for $20,000. The equipment will be depreciated using a five-year MACRS depreciation schedule. If the equipment is sold at the end of its fourth year for $12,000, what are the after-tax proceeds from th

> When forecasting operating expenses, explain the difference between a fixed cost and a variable cost?

> What are variable costs and fixed costs? What are some examples of each? How are these costs estimated in forecasting operating expenses?

> Why do analysts care about how sensitive EBITDA and EBIT are to changes in revenue?

> Healthy Potions, Inc., a pharmaceutical company, bought a machine at a cost of $2 million five years ago that produces pain-reliever medicine. The machine has been depreciated over the past five years, and the current book value is $800,000. The company

> What is the difference between average tax rate and the marginal tax rate? Which one should we use in calculating incremental after-tax cash flows?

> What is the difference between nominal and real cash flows? Which rate of return should we use to discount each type of cash flow?

> After estimating a project’s NPV, the analyst is advised that the fixed capital outlay will be revised upward by $100,000. The fixed capital outlay is depreciated straight-line over an eight-year life. The tax rate is 40 percent, and the required rate of

> FITCO is considering the purchase of new equipment. The equipment costs $350,000, and an additional $110,000 is needed to install it. The equipment will be depreciated straight-line to zero over a five-year life. The equipment will generate additional an

> The alternative to investing in the new production line in Problem 11.36 is to overhaul the existing line, which currently has both a book value and a salvage value of $0. It would cost $300,000 to overhaul the existing line, but this expenditure would e

> ACME Manufacturing is considering replacing an existing production line with a new line that has a greater output capacity and operates with less labor than the existing line. The new line would cost $1 million, have a five-year life, and be depreciated

> Biotech Partners LLC has been farming a new strain of radioactive-material-eating bacteria that the electrical utility industry can use to help dispose of its nuclear waste. Two opposing factors affect Biotech’s decision of when to harvest the bacteria.

> Great Fit, Inc., is a company that manufactures clothing. The company has a production line that produces women’s tops of regular sizes. The same machine could be used to produce petite sizes as well. However, the remaining life of the machines will be r

> A beauty product company is developing a new fragrance named Happy Forever. There is a probability of 0.5 that consumers will love Happy Forever, and in this case, annual sales will be 1 million bottles; a probability of 0.4 that consumers will find the

> How do we decide when to harvest an asset?

> List the major stock market indexes, and explain what they tell us?

> Rocky Mountain Lumber, Inc., is considering purchasing a new wood saw that costs $50,000. The saw will generate revenues of $100,000 per year for five years. The cost of materials and labor needed to generate these revenues will total $60,000 per year, a

> Merton Shovel Corporation has decided to bid for a contract to supply shovels to the Honduran Army. The Honduran Army intends to buy 1,000 shovels per year for the next three years. To supply these shovels, Merton will have to acquire manufacturing equip

> You are the CFO of SlimBody, Inc., a retailer of the exercise machine Slimbody6 and related accessories. Your firm is considering opening up a new store in Los Angeles. The store will have a life of 20 years. It will generate annual sales of 5,000 exerci

> How do we adjust for depreciation when we calculate incremental after-tax free cash flow from EBITDA? What is the intuition for the adjustment?

> You are thinking about delivering pizzas in your spare time. Since you must use your own car to deliver the pizzas, you will wear out your current car one year earlier, which is one year from today, than if you did not take on the delivery job. You estim

> Anaconda Manufacturing Company currently own a mine that is known to contain a certain amount of gold. Since Anaconda does not have any gold-mining expertise, the company plans to sell the entire mine and base the selling price on a fixed multiple of the

> Assume that you are considering replacing your old Nissan with a new Hyundai, as in the previous problem. However, the annual maintenance cost of the old Nissan increases as time goes by. It is $1,200 in the first year, $1,500 in the second year, and $1,

> You have a 2000 Nissan that is expected to run for another three years, but you are considering buying a new Hyundai before the Nissan wears out. You will donate the Nissan to Goodwill when you buy the new car. The annual maintenance cost is $1,500 per y

> Bell Mountain Vineyards is considering updating its current manual accounting system with a high-end electronic system. While the new accounting system would save the company money, the cost of the system continues to decline. The Bell Mountainâ&#1

> Predator LLC, a leveraged-buyout specialist, recently bought a company and wants to determine the optimal time to sell it. The partner in charge of this investment has estimated the after-tax cash flows from a sale at different times to be as follows: $7

> When can we not simply compare the NPVs of two mutually exclusive projects?

> You are starting a family pizza parlor and need to buy a motorcycle for delivery orders. You have two models in mind. Model A costs $9,000 and is expected to run for 6 years; Model B is more expensive, with a price of $14,000, and has an expected life of

> You are trying to choose between purchasing one of two machines for a factory. Machine A costs $15,000 to purchase and has a three-year life. Machine B costs $17,700 to purchase but has a four year life. Regardless of which machine you purchase, it will

> 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 eq

> Given the soaring price of gasoline, Ford is considering introducing a new production line of gas-electric hybrid sedans. The expected annual unit sales of the hybrid cars is 30,000; the price is $22,000 per car. Variable costs of production are $10,000

> Healthy Potions, Inc., is considering investing in a new production line for eye drops. Other than investing in the equipment, the company needs to increase its cash and cash equivalents by $10,000, increase the level of inventory by $30,000, increase ac

> You are buying a sofa. You will pay $200 today and make three consecutive annual payments of $300 in the future. The real rate of return is 10 percent, and the expected inflation rate is 4 percent. What is the actual price of the sofa?

> Explain the concept of equivalent annual cost and how it is used to compare projects with different lives?

> Define expected cash flows, and explain why this concept is important in evaluating projects?

> Keswick Supply Company wants to set up a division that provides copy and fax services to businesses. Customers will be given 20 days to pay for such services. The annual revenue of the division is estimated to be $25,000. Assuming that the customers take

> Why do we use forecasted incremental after-tax free cash flows instead of forecasted accounting earnings in estimating the NPV of a project?