Question: Prices of zero-coupon, default-free securities

> Your firm would like to evaluate a proposed new operating division. You have forecasted cash flows for this division for the next five years, and have estimated that the cost of capital is 12%. You would like to estimate a continuation value. You have ma

> Bay Properties is considering starting a commercial real estate division. It has prepared the following four-year forecast of free cash flows for this division: Assume cash flows after year 4 will grow at 3% per year, forever. If the cost of capital fo

> Arnold Inc. is considering a proposal to manufacture high-end protein bars used as food supplements by body builders. The project requires use of an existing warehouse, which the firm acquired three years ago for $1 million and which it currently rents o

> Your firm is considering a project that would require purchasing $7.5 million worth of new equipment. Determine the present value of the depreciation tax shield associated with this equipment if the firm’s tax rate is 40%, the appropriate cost of capital

> Consider again the choice between outsourcing and in-house assembly of Home Net discussed in Section 8.3 and analyzed in Table 8.6. Suppose, however, that the upfront cost to set up for in-house production is $6 million rather than $5 million, and the co

> A bicycle manufacturer currently produces 300,000 units a year and expects output levels to remain steady in the future. It buys chains from an outside supplier at a price of $2 a chain. The plant manager believes that it would be cheaper to make these c

> The following quote on Yahoo! stock appeared on July 23, 2015, on Yahoo! Finance: If you wanted to buy Yahoo!, what price would you pay? How much would you receive if you wanted to sell Yahoo!? Yahoo! Inc. (YHOO) - NasdagGS 39.55 +0.31(0.79%) 12:0P

> Using the assumptions in part (a) of Problem 5 (assuming there is no cannibalization), a. Calculate Home Net’s net working capital requirements (that is, reproduce Table 8.4 under the assumptions in Problem 5(a)). b. Calculate Home Net’s FCF (that is, re

> You are considering an investment in a clothes distributor. The company needs $100,000 today and expects to repay you $120,000 in a year from now. What is the IRR of this investment opportunity? Given the riskiness of the investment opportunity, your cos

> You are CEO of Rivet Networks, maker of ultra-high performance network cards for gaming computers, and you are considering whether to launch a new product. The product, the Killer X3000, will cost $900,000 to develop up front (year 0), and you expect rev

> Open Seas, Inc. is evaluating the purchase of a new cruise ship. The ship would cost $500 million, and would operate for 20 years. Open Seas expects annual cash flows from operating the ship to be $70 million (at the end of each year) and its cost of cap

> Fast Track Bikes, Inc. is thinking of developing a new composite road bike. Development will take six years and the cost is $200,000 per year. Once in production, the bike is expected to make $300,000 per year for 10 years. Assume the cost of capital is

> Bill Clinton reportedly was paid $15 million to write his book My Life. Suppose the book took three years to write. In the time he spent writing, Clinton could have been paid to make speeches. Given his popularity, assume that he could earn $8 million pe

> Your firm is considering the launch of a new product, the XJ5. The upfront development cost is $10 million, and you expect to earn a cash flow of $3 million per year for the next five years. Plot the NPV profile for this project for discount rates rangin

> Kaimalino Properties (KP) is evaluating six real estate investments. Management plans to buy the properties today and sell them five years from today. The following table summarizes the initial cost and the expected sale price for each property, as well

> You own a car dealership and are trying to decide how to configure the showroom floor. The floor has 2000 square feet of usable space. You have hired an analyst and asked her to estimate the NPV of putting a particular model on the floor and how much spa

> Natasha’s Flowers, a local florist, purchases fresh flowers each day at the local flower market. The buyer has a budget of $1000 per day to spend. Different flowers have different profit margins, and also a maximum amount the shop can s

> Explain how the bid-ask spread is determined in most markets today.

> Facebook is considering two proposals to overhaul its network infrastructure. They have received two bids. The first bid, from Huawei, will require a $20 million upfront investment and will generate $20 million in savings for Facebook each year for the n

> You are considering a safe investment opportunity that requires a $1000 investment today, and will pay $500 two years from now and another $750 five years from now. a. What is the IRR of this investment? b. If you are choosing between this investment and

> Consider two investment projects, both of which require an upfront investment of $10 million and pay a constant positive amount each year for the next 10 years. Under what conditions can you rank these projects by comparing their IRRs?

> You are evaluating the following two projects: Use the incremental IRR to determine the range of discount rates for which each project is optimal to undertake. Note that you should also include the range in which it does not make sense to take either p

> You work for an outdoor play structure manufacturing company and are trying to decide between two projects: You can undertake only one project. If your cost of capital is 8%, use the incremental IRR rule to make the correct decision. Year-End Cash

> You have just started your summer internship, and your boss asks you to review a recent analysis that was done to compare three alternative proposals to enhance the firm’s manufacturing facility. You find that the prior analysis ranked

> You are a real estate agent thinking of placing a sign advertising your services at a local bus stop. The sign will cost $5000 and will be posted for one year. You expect that it will generate additional revenue of $500 per month. What is the payback per

> You are considering constructing a new plant in a remote wilderness area to process the ore from a planned mining operation. You anticipate that the plant will take a year to build and cost $100 million upfront. Once built, it will generate cash flows of

> You are considering investing in a start-up company. The founder asked you for $200,000 today and you expect to get $1,000,000 in nine years. Given the riskiness of the investment opportunity, your cost of capital is 20%. What is the NPV of the investmen

> Your firm has been hired to develop new software for the university’s class registration system. Under the contract, you will receive $500,000 as an upfront payment. You expect the development costs to be $450,000 per year for the next three years. Once

> See Table 2.5 showing financial statement data and stock price data for Mydeco Corp. Suppose Mydeco’s costs and expenses had been the same fraction of revenues in 2013–2016 as they were in 2012. What would Mydeco&acirc

> Your firm spends $500,000 per year in regular maintenance of its equipment. Due to the economic downturn, the firm considers forgoing these maintenance expenses for the next three years. If it does so, it expects it will need to spend $2 million in year

> You have 3 projects with the following cash flows: a. For which of these projects is the IRR rule reliable? b. Estimate the IRR for each project (to the nearest 1%). c. What is the NPV of each project if the cost of capital is 5%? 20%? 50%? Year 2

> How many IRRs are there in part (a) of Problem 5? Does the IRR rule give the right answer in this case? How many IRRs are there in part (b) of Problem 5? Does the IRR rule work in this case? Data from Problem 5: Bill Clinton reportedly was paid $15 mil

> You have been offered a very long term investment opportunity to increase your money one hundredfold. You can invest $1000 today and expect to receive $100,000 in 40 years. Your cost of capital for this (very risky) opportunity is 25%. What does the IRR

> Your brother wants to borrow $10,000 from you. He has offered to pay you back $12,000 in a year. If the cost of capital of this investment opportunity is 10%, what is its NPV? Should you undertake the investment opportunity? Calculate the IRR and use it

> Explain why the yield of a bond that trades at a discount exceeds the bond’s coupon rate.

> The prices of several bonds with face values of $1000 are summarized in the following table: For each bond, state whether it trades at a discount, at par, or at a premium. Bond A В D Price $972.50 $1040.75 $1150.00 $1000.00

> Suppose a 10-year, $1000 bond with an 8% coupon rate and semiannual coupons is trading for a price of $1034.74. a. What is the bond’s yield to maturity (expressed as an APR with semiannual compounding)? b. If the bond’s yield to maturity changes to 9% AP

> In the Global Financial Crisis box in Section 6.1, www.Bloomberg.com reported that the three month Treasury bill sold for a price of $100.002556 per $100 face value. What is the yield to maturity of this bond, expressed as an EAR?

> Suppose the current zero-coupon yield curve for risk-free bonds is as follows: a. What is the price per $100 face value of a two-year, zero-coupon, risk-free bond? b. What is the price per $100 face value of a four-year, zero-coupon, risk-free bond? c.

> Describe the important changes that have occurred in stock markets over the last decade.

> Suppose the yield on German government bonds is 1%, while the yield on Spanish government bonds is 6%. Both bonds are denominated in euros. Which country do investors believe is more likely to default? How can you tell?

> What does it mean for a country to “inflate away” its debt? Why might this be costly for investors even if the country does not default?

> The Isabelle Corporation rents prom dresses in its stores across the southern United States. It has just issued a five-year, zero-coupon corporate bond at a price of $74. You have purchased this bond and intend to hold it until maturity. a. What is the y

> The following table summarizes prices of various default-free, zero-coupon bonds (expressed as a percentage of face value): a. Compute the yield to maturity for each bond. b. Plot the zero-coupon yield curve (for the first five years). c. Is the yield

> Grummon Corporation has issued zero-coupon corporate bonds with a five-year maturity. Investors believe there is a 20% chance that Grummon will default on these bonds. If Grummon does default, investors expect to receive only 50 cents per dollar they are

> In the Data Case in Chapter 5, we suggested using the yield on Florida Sate bonds to estimate the State of Florida’s cost of capital. Why might this estimate overstate the actual cost of capital?

> Explain why the expected return of a corporate bond does not equal its yield to maturity.

> Suppose you are given the following information about the default-free, coupon-paying yield curve: a. Use arbitrage to determine the yield to maturity of a two-year, zero-coupon bond. b. What is the zero-coupon yield curve for years 1 through 4? Ma

> Assume there are four default-free bonds with the following prices and future cash flows: Do these bonds present an arbitrage opportunity? If so, how would you take advantage of this opportunity? If not, why not? Cash Flows Bond Price Today Year 1

> What is the difference between a public and a private corporation?

> Consider a five-year, default-free bond with annual coupons of 5% and a face value of $1000. a. Without doing any calculations, determine whether this bond is trading at a premium or at a discount. Explain. b. What is the yield to maturity on this bond?

> Consider a four-year, default-free security with annual coupon payments and a face value of $1000 that is issued at par. What is the coupon rate of this bond? Data for Problem 21: Maturity (years) 1 3 4 5 Zero-coupon YTM 4.00% 4.30% 4.50% 4.70% 4.8

> What is the maturity of a default-free security with annual coupon payments and a yield to maturity of 4%? Why? Data for Problem 20: Maturity (years) 1 3 4 5 Zero-coupon YTM 4.00% 4.30% 4.50% 4.70% 4.80%

> What is the price of a three-year, default-free security with a face value of $1000 and an annual coupon rate of 4%? What is the yield to maturity for this bond? Data for Problem 19: Maturity (years) 1 3 4 5 Zero-coupon YTM 4.00% 4.30% 4.50% 4.70%

> What is the price of a five-year, zero-coupon, default-free security with a face value of $1000? Data for Problem 18: Maturity (years) 1 3 4 5 Zero-coupon YTM 4.00% 4.30% 4.50% 4.70% 4.80%

> What is the price today of a two-year, default-free security with a face value of $1000 and an annual coupon rate of 6%? Does this bond trade at a discount, at par, or at a premium? Data for Problem 17: Maturity (years) 1 3 4 5 Zero-coupon YTM 4.00

> Suppose the current yield on a one-year, zero coupon bond is 3%, while the yield on a five-year, zero coupon bond is 5%. Neither bond has any risk of default. Suppose you plan to invest for one year. You will earn more over the year by investing in the f

> Suppose you purchase a 30-year Treasury bond with a 5% annual coupon, initially trading at par. In 10 years’ time, the bond’s yield to maturity has risen to 7% (EAR). a. If you sell the bond now, what internal rate of return will you have earned on your

> Consider the following bonds: a. What is the percentage change in the price of each bond if its yield to maturity falls from 6% to 5%? b. Which of the bonds A–D is most sensitive to a 1% drop in interest rates from 6% to 5% and why? W

> Suppose that Ally Financial Inc. issued a bond with 10 years until maturity, a face value of $1000, and a coupon rate of 7% (annual payments). The yield to maturity on this bond when it was issued was 6%. a. What was the price of this bond when it was is

> Are hostile takeovers necessarily bad for firms or their investors? Explain.

> Suppose a seven-year, $1000 bond with an 8% coupon rate and semiannual coupons is trading with a yield to maturity of 6.75%. a. Is this bond currently trading at a discount, at par, or at a premium? Explain. b. If the yield to maturity of the bond rises

> A 30-year bond with a face value of $1000 has a coupon rate of 5.5%, with semiannual payments. a. What is the coupon payment for this bond? b. Draw the cash flows for the bond on a timeline.

> Suppose you invest $100 in a bank account, and five years later it has grown to $134.39. a. What APR did you receive, if the interest was compounded semiannually? b. What APR did you receive if the interest was compounded monthly?

> You can earn $50 in interest on a $1000 deposit for eight months. If the EAR is the same regardless of the length of the investment, determine how much interest you will earn on a $1000 deposit for a. 6 months. b. 1 year. c. 1⁄2 years.

> You are considering moving your money to a new bank offering a one-year CD that pays an 8% APR with monthly compounding. Your current bank’s manager offers to match the rate you have been offered. The account at your current bank would pay interest every

> After reading the Novy-Marx and Rauh article (see the Common Mistake Box on page 161), you decide to compute the total obligation of the state you live in. After some research you determine that your state’s promised pension payments amount to $1 billion

> Your firm is considering the purchase of a new office phone system. You can either pay $32,000 now, or $1000 per month for 36 months. a. Suppose your firm currently borrows at a rate of 6% per year (APR with monthly compounding). Which payment plan is mo

> In the summer of 2008, at Heathrow Airport in London, Best of the best (BB), a private company, offered a lottery to win a Ferrari or 90,000 British pounds, equivalent at the time to about $180,000. Both the Ferrari and the money, in 100-pound notes, wer

> Suppose you have outstanding debt with an 8% interest rate that can be repaid any time, and the interest rate on U.S. Treasuries is only 5%. You plan to repay your debt using any cash that you don’t invest elsewhere. Until your debt is repaid, what cost

> Your best friend consults you for investment advice. You learn that his tax rate is 35%, and he has the following current investments and debts: A car loan with an outstanding balance of $5000 and a 4.8% APR (monthly compounding) Credit cards with an out

> You are the CEO of a company and you are considering entering into an agreement to have your company buy another company. You think the price might be too high, but you will be the CEO of the combined, much larger company. You know that when the company

> You are enrolling in an MBA program. To pay your tuition, you can either take out a standard student loan (so the interest payments are not tax deductible) with an EAR of 51⁄2% or you can use a tax-deductible home equity loan with an APR (monthly) of 6%.

> Your uncle Fred just purchased a new boat. He brags to you about the low 7% interest rate (APR, monthly compounding) he obtained from the dealer. The rate is even lower than the rate he could have obtained on his home equity loan (8% APR, monthly compoun

> Your best taxable investment opportunity has an EAR of 4%. Your best tax-free investment opportunity has an EAR of 3%. If your tax rate is 30%, which opportunity provides the higher after-tax interest rate?

> Figure 5.4 shows that Johnson and Johnson’s five-year borrowing rate is 1.9% and Xerox’s is 4.0%. Which would you prefer? $500 from Johnson and Johnson paid today or a promise that the firm will pay you $575 in five ye

> Suppose the current one-year interest rate is 6%. One year from now, you believe the economy will start to slow and the one-year interest rate will fall to 5%. In two years, you expect the economy to be in the midst of a recession, causing the Federal Re

> What is the shape of the yield curve given the term structure in Problem 29? What expectations are investors likely to have about future interest rates? Data from Problem 29: Suppose the term structure of risk-free interest rates is as shown below: a

> Using the term structure in Problem 29, what is the present value of an investment that pays $100 at the end of each of years 1, 2, and 3? If you wanted to value this investment correctly using the annuity formula, which discount rate should you use? Da

> Many academic institutions offer a sabbatical policy. Every seven years a professor is given a year free of teaching and other administrative responsibilities at full pay. For a professor earning $70,000 per year who works for a total of 42 years, what i

> Suppose the term structure of risk-free interest rates is as shown below: a. Calculate the present value of an investment that pays $1000 in two years and $2000 in five years for certain. b. Calculate the present value of receiving $500 per year, with

> Consider a project that requires an initial investment of $100,000 and will produce a single cash flow of $150,000 in five years. a. What is the NPV of this project if the five-year interest rate is 5% (EAR)? b. What is the NPV of this project if the fiv

> Suppose that in 2016, Global launches an aggressive marketing campaign that boosts sales by 15%. However, their operating margin falls from 5.57% to 4.50%. Suppose that they have no other income, interest expenses are unchanged, and taxes are the same pe

> Can the nominal interest rate available to an investor be significantly negative? Can the real interest rate be negative? Explain.

> You need a new car and the dealer has offered you a price of $20,000, with the following payment options: (a) pay cash and receive a $2000 rebate, or (b) pay a $5000 down payment and finance the rest with a 0% APR loan over 30 months. But having just qui

> Your friend tells you he has a very simple trick for shortening the time it takes to repay your mortgage by one-third: Use your holiday bonus to make an extra payment on January 1 of each year (that is, pay your monthly payment due on that day twice). As

> Oppenheimer Bank is offering a 30-year mortgage with an APR of 5.25% based on monthly compounding. With this mortgage your monthly payments would be $2,000 per month. In addition, Oppenheimer Bank offers you the following deal: Instead of making the mont

> Your mortgage has 25 years left, and has an APR of 7.625% with monthly payments of $1449. a. What is the outstanding balance? b. Suppose you cannot make the mortgage payment and you are in danger of losing your house to foreclosure. The bank has offered

> You have just purchased a home and taken out a $500,000 mortgage. The mortgage has a 30-year term with monthly payments and an APR of 6%. a. How much will you pay in interest, and how much will you pay in principal, during the first year? b. How much wil

> Oppenheimer Bank is offering a 30-year mortgage with an EAR of 53⁄8%. If you plan to borrow $150,000, what will your monthly payment be?

> You make monthly payments on your mortgage. It has a quoted APR of 5% (monthly compounding). What percentage of the outstanding principal do you pay in interest each month?

> Your son has been accepted into college. This college guarantees that your son’s tuition will not increase for the four years he attends college. The first $10,000 tuition payment is due in six months. After that, the same payment is due every six months

> You are thinking of retiring. Your retirement plan will pay you either $250,000 immediately on retirement or $350,000 five years after the date of your retirement. Which alternative should you choose if the interest rate is a. 0% per year? b. 8% per year

> Corporate managers work for the owners of the corporation. Consequently, they should make decisions that are in the interests of the owners, rather than their own. What strategies are available to shareholders to help ensure that managers are motivated t

> What is the most important difference between a corporation and all other organizational forms?

> On March 31, 2018, the balances of the accounts appearing in the ledger of Royal Furnishings Company, a furniture wholesaler, are as follows: A. Prepare a multiple-step income statement for the year ended March 31, 2018. B. Compare the major advantages

> Alert Security Services Co. offers security services to business clients. Complete the following end-of-period spreadsheet for Alert Security Services Co.: Alert Security Services Co. End-of-Period Spreadsheet For the Year Ended October 31, 2018 Adj

> The following expenses were incurred by a merchandising business during the year. In which expense section of the income statement should each be reported: (A) selling, (B) administrative, or (C) other? 1. Advertising expense 2. Depreciation expense on s

> Financial information related to Ebony Interiors for February and March 2018 is as follows: A. Prepare balance sheets for Ebony Interiors as of February 28 and March 31, 2018. B. Determine the amount of net income for March, assuming that no additional

> Rearrange the following steps in the accounting cycle in proper sequence: A. A post-closing trial balance is prepared. B. Adjustment data are assembled and analyzed. C. Adjusting entries are journalized and posted to the ledger. D. An adjusted trial bala