Many firms have devised defenses that make it more difficult or costly for other firms to take them over. How might such defenses affect the firm’s agency problems? Are managers of firms with formidable takeover defenses more or less likely to act in the shareholders’ interests rather than their own? What would you expect to happen to the share price when management proposes to institute such defenses?
> Here are some historical data on the risk characteristics of Bank of America and Starbucks: Assume the standard deviation of the return on the market was 23.0%. a. The correlation coefficient of Bank of America’s return versus Starbucks is .30. What i
> Borgia Pharmaceuticals has $1 million allocated for capital expenditures. Which of the following projects should the company accept to stay within the $1 million budget? How much does the budget limit cost the company in terms of its market value? The op
> A common stock will pay a cash dividend of $4 next year. After that, the dividends are expected to increase indefinitely at 4% per year. If the discount rate is 14%, what is the PV of the stream of dividend payments?
> You can form a portfolio of two assets, A and B, whose returns have the following characteristics: If you demand an expected return of 12%, what are the portfolio weights? What is the portfolio’s standard deviation?
> There are few, if any, real companies with negative betas. But suppose you found one with β = –.25. a. How would you expect this stock’s rate of return to change if the overall market rose by an extra 5%? What if the market fell by an extra 5%? b. You h
> Your eccentric Aunt Claudia has left you $50,000 in BP shares plus $50,000 cash. Unfortunately her will requires that the BP stock not be sold for one year and the $50,000 cash must be entirely invested in one of the stocks shown in Table 7.9. What is th
> a. How many variance terms and how many different covariance terms do you need to calculate the risk of a 100-share portfolio? b. Suppose all stocks had a standard deviation of 30% and a correlation with each other of .4. What is the standard deviation
> Halcyon Lines is considering the purchase of a new bulk carrier for $8 million. The forecasted revenues are $5 million a year and operating costs are $4 million. A major refit costing $2 million will be required after both the fifth and tenth years. Aft
> Hyacinth Macaw invests 60% of her funds in stock I and the balance in stock J. The standard deviation of returns on I is 10%, and on J it is 20%. Calculate the variance of portfolio returns, assuming a. The correlation between the returns is 1.0. b. Th
> Lonesome Gulch Mines has a standard deviation of 42% per year and a beta of +.10. Amalgamated Copper has a standard deviation of 31% a year and a beta of +.66. Explain why Lonesome Gulch is the safer investment for a diversified investor.
> Hippique s.a., which owns a stable of racehorses, has just invested in a mysterious black stallion with great form but disputed bloodlines. Some experts in horseflesh predict the horse will win the coveted Prix de Bidet; others argue that it should be pu
> Each of the following statements is dangerous or misleading. Explain why. a. A long-term United States government bond is always absolutely safe. b. All investors should prefer stocks to bonds because stocks offer higher long-run rates of return. c. T
> Here are inflation rates and U.S. stock market and Treasury bill returns between 1929 and 1933: a. What was the real return on the stock market in each year? b. What was the arithmatic average real return? c. What was the risk premium in each year? d.
> Consider the following capital rationing problem: Set up this problem as a linear program and solve it. You can allow partial investments, that is, 0 ≤ x ≤ 1. Calculate and interpret the shadow prices16 on the capi
> Look again at projects D and E in Section 5-3. Assume that the projects are mutually exclusive and that the opportunity cost of capital is 10%. a. Calculate the profitability index for each project. b. Show how the profitability-index rule can be used to
> What is the beta of each of the stocks shown in table
> A portfolio contains equal investments in 10 stocks. Five have a beta of 1.2; the remainder have a beta of 1.4. What is the portfolio beta? a. 1.3. b. Greater than 1.3 because the portfolio is not completely diversified. c. Less than 1.3 because divers
> Suppose the standard deviation of the market return is 20%. a. What is the standard deviation of returns on a well-diversified portfolio with a beta of 1.3? b. What is the standard deviation of returns on a well-diversified portfolio with a beta of 0?
> To calculate the variance of a three-stock portfolio, you need to add nine boxes: Use the same symbols that we used in this chapter; for example, x1 = proportion invested in stock 1 and σ12 = covariance between stocks 1 and 2. Now complete the nine bo
> In which of the following situations would you get the largest reduction in risk by spreading your investment across two stocks? a. The two shares are perfectly correlated. b. There is no correlation. c. There is modest negative correlation. d. There
> A factory costs $400,000. It will produce an inflow after operating costs of $100,000 in year 1, $200,000 in year 2, and $300,000 in year 3. The opportunity cost of capital is 12%. Show your calculations in a time line like Figures 2.4 and 2.5. Calculat
> True or false? a. Investors prefer diversified companies because they are less risky. b. If stocks were perfectly positively correlated, diversification would not reduce risk. c. Diversification over a large number of assets completely eliminates ris
> During the boom years of 2010–2014, ace mutual fund manager Diana Sauros produced the following percentage rates of return. Rates of return on the market are given for comparison. Calculate the average return and standard deviation of Ms. Sauros’s mut
> The following table shows the nominal returns on the U.S. stocks and the rate of inflation. a. What was the standard deviation of the nominal market returns? b. Calculate the arithmetic average real return.
> In most large corporations, ownership and management are separated. What are the main implications of this separation?
> In the early 1990s, the California Air Resources Board (CARB) started planning its “Phase 2” requirements for reformulated gasoline (RFG). RFG is gasoline blended to tight specifications designed to reduce pollution from motor vehicles. CARB consulted wi
> IRR rule The Titanic Shipbuilding Company has a noncancelable contract to build a small cargo vessel. Construction involves a cash outlay of $250,000 at the end of each of the next two years. At the end of the third year the company will receive payment
> In 1898, Simon North announced plans to construct a funeral home on land he owned and rented out as a storage area for railway carts. (A local newspaper commended Mr. North for not putting the cart before the hearse.) Rental income from the site ba
> Which of the following should be treated as incremental cash flows when deciding whether to invest in a new manufacturing plant? The site is already owned by the company, but existing buildings would need to be demolished. a. The market value of the site
> We warned that equivalent annual costs should be calculated in real terms. We did not fully explain why. This problem will show you. Look back to the cash flows for machines A and B (in “The Choice between Long- and Short-Lived Equipment”). The present v
> One measure of the effective tax rate is the difference between the IRRs of pretax and after-tax cash flows, divided by the pretax IRR. Consider, for example, an investment I generating a perpetual stream of pretax cash flows C. The pretax IRR is C/I, an
> The president’s executive jet is not fully utilized. You judge that its use by other officers would increase direct operating costs by only $20,000 a year and would save $100,000 a year in airline bills. On the other hand, you believe that with the incre
> Look again at your calculations for Problem 29. Suppose that technological change is expected to reduce costs by 10% per year. There will be new machines in year 1 that cost 10% less to buy and operate than A and B. In year 2 there will be a second crop
> Explain why we refer to the opportunity cost of capital, instead of just “cost of capital” or “discount rate.” While you’re at it, also explain the following statement: “The opportunity cost of capital depends on the proposed use of cash, not the source
> The Borstal Company has to choose between two machines that do the same job but have different lives. The two machines have the following costs: These costs are expressed in real terms. a. Suppose you are Borstal’s financial manager. I
> An investment costs $1,548 and pays $138 in perpetuity. If the interest rate is 9%, what is the NPV?
> Which of the following are real assets, and which are financial? a. A share of stock. b. A personal IOU. c. A trademark. d. A factory. e. Undeveloped land. f. The balance in the firm’s checking account. g. An experienced and hardworking sales forc
> Consider the following projects: a. If the opportunity cost of capital is 10%, which projects have a positive NPV? b. Calculate the payback period for each project. c. Which project(s) would a firm using the payback rule accept if the cutoff period were
> Read the following passage: “Companies usually buy (a) assets. These include both tangible assets such as (b) and intangible assets such as (c). To pay for these assets, they sell (d) assets such as (e). The decision about which assets to buy is u
> Suppose you have the following investment opportunities, but only $90,000 available for investment. Which projects should you take? Project NPV Investment 1 5,000 10,000 5,000 5,000 3 10,000 90,000 4 15,000 60,000 5 15,000 75,000 6 3,000 15,000
> Consider projects Alpha and Beta: The opportunity cost of capital is 8%. Suppose you can undertake Alpha or Beta, but not both. Use the IRR rule to make the choice. Cash Flows ($) Project Co C2 IRR (%) Alpha -400,000 +241,000 +293,000 21 Beta -200,00
> Consider a project with the following cash flows: a. How many internal rates of return does this project have? b. Which of the following numbers is the project IRR: (i) –50%; (ii) –12%; (iii) +5%; (iv) +50%? c. The
> You have the chance to participate in a project that produces the following cash flows: The internal rate of return is 13%. If the opportunity cost of capital is 10%, would you accept the offer? Cash Flows ($) Co +5,000 +4,000 -11,000
> Calculate the net present value of the following project for discount rates of 0, 50, and 100%: What is the IRR of the project? Cash Flows ($) Co -6,750 +4,500 +18,000
> Write down the equation defining a project’s internal rate of return (IRR). In practice how is IRR calculated?
> Vegetron’s chief financial officer (CFO) is wondering how to analyze a proposed $1 million investment in a new venture code-named project X. He asks what you think. Your response should be as follows: “First, forecast
> Respond briefly to the following statement: “You say stock price equals the present value of future dividends? That’s crazy! All the investors I know are looking for capital gains.”
> Suppose the horizon date is set at a time when the firm will run out of positive-NPV investment opportunities. How would you calculate the horizon value?
> What is meant by the “horizon value” of a business? How can it be estimated?
> What do financial managers mean by “free cash flow”? How is free cash flow calculated? Briefly explain.
> Under what conditions does r, a stock’s market capitalization rate, equal its earnings–price ratio EPS1/P0?
> If company Z (see Problem 5) were to distribute all its earnings, it could maintain a level dividend stream of $15 a share. How much is the market actually paying per share for growth opportunities? Problem 5: Company Z’s earnings and dividends per shar
> Company Z’s earnings and dividends per share are expected to grow indefinitely by 5% a year. If next year’s dividend is $10 and the market capitalization rate is 8%, what is the current stock price?
> Company Y does not plow back any earnings and is expected to produce a level dividend stream of $5 a share. If the current stock price is $40, what is the market capitalization rate?
> Company X is expected to pay an end-of-year dividend of $5 a share. After the dividend its stock is expected to sell at $110. If the market capitalization rate is 8%, what is the current stock price?
> Portfolio managers are frequently paid a proportion of the funds under management. Suppose you manage a $100 million equity portfolio offering a dividend yield (DIV1/P0) of 5%. Dividends and portfolio value are expected to grow at a constant rate. Your a
> The constant-growth DCF formula: P0 = DIV1 /r − g is sometimes written as: P0 = ROE (1 − b) BVPS / r − b ROE where BVPS is book equity value per share, b is the plowback ratio, and ROE is the ratio of earnings per share to BVPS. Use this equation
> Phoenix Corp. faltered in the recent recession but is recovering. Free cash flow has grown rapidly. Forecasts made in 2016 are as follows. Phoenix’s recovery will be complete by 2021, and there will be no further growth in free cash&Aci
> Mexican Motors’ market cap is 200 billion pesos. Next year’s free cash flow is 8.5 billion pesos. Security analysts are forecasting that free cash flow will grow by 7.5% per year for the next five years. a. Assume that the 7.5% growth rate is expected to
> Why might one expect managers to act in shareholders’ interests? Give some reasons.
> Look back to the numerical example graphed in Figure 1A.1. Suppose the interest rate is 20%. What would the ant (A) and grasshopper (G) do if they both start with $100,000? Would they invest in their friend’s business? Would they borrow or lend? How muc
> Comparative consolidated financial statements for Pop Corporation and its subsidiary, Son Corporation, at and for the years ended December 31, 2017 and 2016 follow (in thousands). Pop Corporation and Subsidiary Comparative Consolidated Financial Stateme
> Pam Corporation paid $10,000,000 for Sun Corporation’s voting common stock on January 2, 2016, and Sun was dissolved. The purchase price consisted of 200,000 shares of Pam’s common stock with a market value of $8,000,0
> Pop Corporation paid $1,800,000 for 90,000 shares of Son Company’s 100,000 outstanding shares on January 1, 2016, when Son’s equity consisted of $1,000,000 of $10 par common stock and $500,000 retained earnings. The ex
> OP company issued 120,000 shares of $10 par common stock with a fair value of $2,550,000 for all the voting common stock of Son Company. In addition, Pop incurred the following additional costs: Legal fees to arrange the business combination ...........
> On January 1, 2009, Pam Corporation acquired 60 percent of the voting common shares of Sun Corporation at an excess of fair value over book value of $1,000,000. This excess was attributed to plant assets with a remaining useful life of five years. For th
> Pam Corporation acquired a 70 percent interest in Sun Corporation’s outstanding voting common stock on January 1, 2016, for $490,000 cash. The stockholders’ equity of Sun on this date consisted of $500,000 capital stoc
> On January 1, Pop Corporation pays $400,000 cash and also issues 36,000 shares of $10 par common stock with a market value of $660,000 for all the outstanding common shares of Son Corporation. In addition, Pop pays $60,000 for registering and issuing the
> Pam Company issued 480,000 shares of $10 par common stock with a fair value of $10,200,000 for all the voting common stock of Sun Company. In addition, Pam incurred the following costs: Legal fees to arrange the business combination ....................
> The stockholders’ equities of Pop Corporation and Son Corporation at January 1 were as follows (in thousands): On January 2, Pop issued 300,000 of its shares with a market value of $20 per share for all of Son’s shar
> 1. Pop Corporation paid $100,000 cash for the net assets of Son Company, which consisted of the following: Assume Son Company is dissolved. The plant and equipment acquired in this business combination should be recorded at: a $220,000 b $200,000 c $18
> The balance sheets of Pop Corporation and Son Corporation at December 31, 2015, are summarized with fair-value information as follows (in thousands): On January 1, 2016, Pop Corporation acquired all of Son’s outstanding stock for $300
> 1. A business combination in which a new corporation is formed to take over the assets and operations of two or more separate business entities, with the previously separate entities being dissolved, is a/an: a Consolidation b Merger c Pooling of interes
> Can gains or losses to a parent/investor result from a subsidiary’s/investee’s treasury stock transactions? Explain.
> Assume that a subsidiary has 10,000 shares of stock outstanding, of which 8,000 shares are owned by the parent. If the parent purchases an additional 2,000 shares of stock directly from the subsidiary at book value, how should the parent record its addit
> Assume that a subsidiary has 10,000 shares of stock outstanding, of which 8,000 shares are owned by the parent. What equity method adjustment will be necessary on the parent books if the subsidiary sells 2,000 additional shares of its own stock to outsid
> Pam Corporation’s Investment in Sun Company account had a balance of $475,000 at December 31, 2016. This balance consisted of goodwill of $35,000 and 80 percent of Sun’s $550,000 stockholders’ equity. On January 2, 2017, Sun increased its outstanding sha
> Pop Corporation purchased an 80 percent interest in Son Corporation for $1,200,000 on January 1, 2017, at which time Son’s stockholders’ equity consisted of $1,000,000 common stock and $400,000 retained earnings. The e
> When a parent sells a part of its interest in a subsidiary during an accounting period, is the income applicable to the interest sold up to the time of sale included in consolidated net income and parent income under the equity method? Explain.
> How is the gain or loss determined for the sale of part of an investment interest that is accounted for as a one-line consolidation? Is the amount of gain or loss affected by the accounting method used by the investor?
> Separate company financial statements for Pop Corporation and its subsidiary, Son Company, at and for the year ended December 31, 2017, are summarized as follows (in thousands): ADDITIONAL INFORMATION: 1. Pop Corporation acquired 13,500 shares of Son C
> Isn’t preacquisition income really noncontrolling interest share?
> On January 2, 2016, Pam Corporation issues its own $10 par common stock for all the outstanding stock of Sun Corporation in an acquisition. Sun is dissolved. In addition, Pam pays $40,000 for registering and issuing securities and $60,000 for other costs
> Assume that an 80 percent investor of Sub Company acquires an additional 10 percent interest in Sub halfway through the current fiscal period. Explain the effect of the 10 percent acquisition by the parent on noncontrolling interest share for the period
> How are preacquisition earnings accounted for by a parent under the equity method? How are they accounted for in the consolidated income statement?
> Explain the terms preacquisition earnings and preacquisition dividends.
> Pam Corporation acquired all the outstanding stock of Sun Corporation on April 1, 2016, for $15,000,000, when Sun’s stockholders’ equity consisted of $5,000,000 capital stock and $2,000,000 retained earnings. The price
> Financial statements for Pop and Son Corporations for 2016 are as follows (in thousands): ADDITIONAL INFORMATION: 1. Pop acquired an 80 percent interest in Son on January 2, 2014, for $580,000, when Son’s stockholdersâ€
> Pam Corporation acquired a 90 percent interest in Sun Corporation on January 1, 2016, for $2,700,000, at which time Sun’s capital stock and retained earnings were $1,500,000 and $900,000, respectively. The fair value cost/book value dif
> Income statement information for 2016 for Pam Corporation and its 60 percent–owned subsidiary, Sun Corporation, is as follows: Intercompany sales for 2016 are upstream (from Sun to Pam) and total $100,000. Pam’s Dece
> Pop Corporation acquired a 90 percent interest in Son Corporation’s outstanding voting common stock on January 1, 2016, for $630,000 cash. The stockholders’ equity of Son on this date consisted of $500,000 capital stoc
> Pam Corporation acquired a 90 percent interest in Sun Corporation on January 1, 2016, for $540,000, at which time Sun’s capital stock and retained earnings were $300,000 and $180,000, respectively. The entire fair value/book value diffe
> Son Corporation, a 90 percent–owned subsidiary of Pop Corporation, was acquired on January 1, 2016, at a price of $90,000 in excess of underlying book value. The excess was due to goodwill. Separate financial statements for Pop and Son
> On January 2, 2016, Pop Corporation enters into a business combination with Son Corporation in which Son is dissolved. Pop pays $1,650,000 for Son, the consideration consisting of 66,000 shares of Pop $10 par common stock with a market value of $25 per s
> Income data from the records of Pam Corporation and Sun Corporation, Pam’s 80 percent–owned subsidiary, for 2016 through 2019 follow (in thousands): Pam acquired its interest in Sun on January 1, 2016, at a price of
> Pop Industries manufactures heavy equipment used in construction and excavation. On January 3, 2016, Pop sold a piece of equipment from its inventory that cost $360,000 to its 60 percent–owned subsidiary, Son Corporation, at Pop’s standard price of twice
> Do common stock dividends and stock splits by a subsidiary affect the amounts that appear in the consolidated financial statements? Explain, indicating the items, if any, that would be affected.
> Pam Corporation has an 80 percent interest in Sun Corporation, its only subsidiary. The 80 percent interest was acquired on July 1, 2016, for $800, at which time Sun’s equity consisted of $600 capital stock and $200 retained earnings. T
> Pop Corporation owns 40 percent of the outstanding voting stock of Son Corporation, acquired for $200,000 on July 1, 2016, when Son’s common stockholders’ equity was $400,000. The excess of investment fair value over book value acquired was due to valuab
> Information needed to prepare the Cash Flow from Operating Activities section of Pam Corporation’s consolidated statement of cash flows is included in the following list: Amortization of patents........................................................ $
