Question: Show that the profitability index (PI), the

> Crest Concrete Inc. has been building basements and slab foundations for new homes in La Crosse, Wisconsin for more than 20 years. However, new home sales have slowed recently and residential construction work is hard to get. As a result, management is c

> New buyers of Simmonds Inc. stock expect a return of about 22%. The firm pays flotation costs of 9% when it issues new securities. What is Simmonds’ cost of equity (Hint: This problem is very simple since we don’t have to estimate the investors’ return

> The New England Brewing Company produces a super-premium beer using a recipe that’s been in the owner’s family since colonial times. Surprisingly, the firm doesn’t own its own brewing facilities, but rents time on the equipment of large brewers who have

> Spitfire Aviation Inc. manufactures small, private aircraft. Management is evaluating a proposal to introduce a new high-performance plane. High performance aviation is an expensive sport undertaken largely by people who are both young and wealthy. Spit

> Vaughn Clothing of the previous problem has a real option possibility. Carlson Flooring has expressed an interest in trading buildings with Vaughn after Vaughn’s is refurbished. Carlson has offered to reimburse Vaughn for 70% of its refurbishment costs

> Vaughn Clothing is considering refurbishing its store at a cost of $1.4 million. Management is concerned about the economy and whether a competitor, Viola Apparel, will open a store in the neighborhood. Vaughn estimates that there is a 60% chance that V

> Resolve the last problem assuming Work Station Inc has an abandonment option at the end of the first year under which it will recover $5 million of the initial investment in year 2. What is the value of the ability to abandon the project? How does your

> The Glendale Corp. is considering a real estate development project that will cost $5M to undertake and is expected to produce annual inflows between $1M and $4M for two years. Management feels that if the project turns out really well the inflows will

> Work Station Inc. manufactures office furniture. The firm is interested in “ergonomic” products that are designed to be easier on the bodies of office workers’ who suffer from aliments such as back a

> Northwest Entertainment Inc. operates a multiplex cinema that has nine small theaters in one building. Business has been good lately and management is considering a project that will add five screens at an estimated cost of $3 million. The success of th

> Outline the arbitrage process proposed by MM that supports the operating income argument. What is the arbitrage between?

> Tyler Inc.'s most recent annual dividend was $3.55 a share. The firm has been growing at a consistent 4% rate for several years, but analysts generally believe that better times are ahead, and that future growth will be in the neighborhood of 5%. The sto

> The Sampson Company issued a $1,000 bond 5 years ago with an initial term of 25 years and a coupon rate of 6%. Today’s interest rate is 10%. a. What is the bond’s current price if interest is paid semiannually as it is on most bonds? b. What is the pric

> The Blazingame Corporation is considering a three-year project that has an initial cash outflow (C0) of $175,000 and three cash inflows that are defined by the independent probability distributions shown below. All dollar figures are in thousands. Blazi

> Assume Keener Clothiers of the last problem assigns the following probabilities to production cost as a percent of revenue Sketch a probability distribution (histogram) for the project’s NPV, and compute its expected NPV. % of Rev

> Weisman Electronics just paid a $1.00 dividend, the market yield is yielding 10%, the risk-free rate is 4%, and Weisman’s beta is 1.5. How fast do investors expect the company to grow in the future if its stock is selling for $27.25.

> Cassidy and Sons is reviewing a project with an initial cash outflow of $250,000. An additional $100,000 will have to be invested after the first year, followed by an additional investment of $50,000 at the end of the second year. Beginning at the end

> Why does it make sense to finance net working capital separately from fixed assets?

> You work in the finance department of a manufacturing company. Over lunch, a friend in the engineering department said she'd heard that the firm used a lot of temporary working capital. Because temporary equipment is usually of lower quality than perma

> The Blivitt Company has been losing money and experiencing serious cash flow problems lately. The main problem is a large debt to the First National Bank, which was used to purchase a computer that's now obsolete. Bill Blivitt, the firm's owner has stat

> Clarington Corp has a division that's been performing well but doesn't fit into the company's long-term strategic plans. Describe the methods through which it can divest the operation.

> Sally Johnson lives in Baltimore, and does business with a large, national brokerage firm. When she sends the broker a check, she mails it to a local address in Baltimore. However, when she receives a check, from the broker, it comes from San Francisco

> Suppose an industry is dominated by three firms, one of which is twice as large as the others, which are about the same size. Could a merger of the two smaller firms actually increase competition in the industry?

> The central issue underlying the study of leverage is whether or not it influences stock price and whether there's an optimal structure. But the whole idea seems kind of fuzzy and uncertain. Why are people so interested? (Hint: Think of management's g

> Explain the difference between pledging and factoring receivables. Which is likely to be more a more expensive source of financing? Is factoring the same kind of financing as pledging?

> What's the difference between a promissory note, a line of credit, and a revolving credit agreement? Are they mutually exclusive? That is, might one be part of the other?

> What are the advantages and disadvantages of stretching payables? If you owned your own business, would you do it? Why or why not?

> You work in the finance department of HiTech Inc. The firm's owner and CEO, Charlie Dollars, is very profit oriented. He understands that short-term interest rates are quite low at the moment, and has suggested that the firm finance all of its working c

> Explain the different circumstances under which firms should use short-term or long-term financing.

> How does a firm's operating cycle differ from its cash conversion cycle? Explain fully.

> Support or challenge each of the following statements individually: a. Because accounts receivables aren't purchased like inventory or fixed assets, they don't require financing. b. Cash represents a pool of available money, so it actually reduces fina

> Working capital is generally defined as the difference between current assets and current liabilities. Is this definition precisely correct? Why?

> The Medco Supply Co. operates out of Waco, Texas, and has a number of customers around Portland, Maine. It seems to take a particularly long time for the Portland customers' payment checks to reach Medco. What can the company do to speed things up? Ex

> Describe the maturity matching principle. What are the risks of not matching maturities? How would you characterize a firm that ignores the principle? Can you think of situations in which it would be advisable for an otherwise prudent firm to deviate

> Describe generally how leverage affects stock prices. What forces are at work, driven by what effects?

> How do repurchases help firms manage the signaling effect of dividends.

> Explain how the two methods of cash distribution work, and describe their impact on shareholders. Does everyone always receive cash? If not, are some stockholders left out?

> You're a financial analyst for a large mutual fund. You're doing an analysis of the Truebright Apparel Company, which makes stylish cotton clothes for teenagers. The company has recently been under attack by foreign competition, and seems to have lost

> You're an investment advisor, and have several well-off older people among your clients. One of these individuals, Charlie Haverty, steadfastly refuses to invest in companies that pay significant dividends. A successful investment counselor advised him

> There is said to be a controversy over dividends. What is it and why is it important?

> Fully explain the choices implied by the dividend decision. Are the results of the choices known or uncertain?

> Leveraged leases offer tax advantages to unprofitable companies. a. Why are they called leveraged? b. Briefly, how do they work?

> Leasing is generally more expensive than borrowing to buy, and FASB 13 has reduced the availability of off-balance sheet financing. Why then is leasing popular?

> Outline the reasons for holding cash and the big cost associated with it. How do these lead to the objective of cash management? How do marketable securities help or hinder achievement of the objective?

> Explain in words how the tax system favors debt financing.

> Briefly summarize the operating income argument that was supported by the original MM result.

> Briefly describe the result of MM's original restrictive model. Why was it important in spite of its serious restrictions?

> Explain the idea of bankruptcy costs. Why are they important to investors? When do investors start to worry about them?

> The Braithwaite Tool Co. is considering a major modernization and automation of its plant using borrowed funds. Fully discuss a serious financial negative that could result from the project.

> Why is the profitability index more appropriately described as a variation on the NPV technique than on the IRR technique?

> Why do labor-intensive processes involve less operating leverage than automated processes? What fixed costs are associated with automation? Why can't those costs be eliminated by just selling the machinery?

> Explain the difference between a fixed and a variable cost. How do these concepts change as the time horizon lengthens? In other words, are the same things fixed over a 5-year planning period that are fixed in a typical 1-year period? What about a 10-

> Dividends are said to be the basis for the value of stocks. If that's true, how do we explain the fact that companies that pay no dividends often have substantial market value? (Such companies are usually relatively young and in high growth fields.) F

> What is the biggest problem associated with financing secured by inventory? How is it addressed in practice?

> Retained earnings are generated by the firm's internal operations and are immediately reinvested to earn more money for the company and its shareholders. Therefore, such funds have zero cost to the company. Is that statement true or false? Explain.

> Explain in words the ROCE test for the advisability of adding leverage. That is, what is the test really telling us? When will it indicate a company is doing the wrong thing?

> Briefly explain the pros and cons of financial leverage. In other words, what are its benefits, and what are the costs that come along with those benefits?

> Both business risk and financial risk would exist with or without either type of leverage. Leverage just makes them more significant. Are these statements true or false? Explain.

> Why are ROE and EPS such important measures of performance to investors?

> Relate business and financial risk as defined in this chapter to the risks described in Chapter 9.

> The user of leverage might be thought of as taking advantage of the provider. Between stockholders and bondholders, who is the user and who is the provider? Give a word explanation or illustration that might support this view. What does the used party

> Define the marginal cost of capital (MCC) and explain in words why it predictably undergoes a step function increase (breaks) as more capital is raised during a budget period.

> Establishing the cost of equity is the most arbitrary and difficult part of developing a firm's cost of capital. Outline the reasons behind this problem and the approaches available to making the best of it.

> A number of investment projects are under consideration at your company. You've calculated the cost of capital based on market values and rates, and analyzed the projects using IRR and NPV. Several projects are marginally acceptable. While watching th

> Describe the concept of beta. Include what it measures and how it's developed.

> There's an issue of historical versus market value with respect to both the cost of capital components and the amounts of those components used in developing weights. We're willing to accept an approximation for the weights, but not for the cost/returns

> The investor's return and the company's cost are opposite sides of the same coin—almost, but not quite. Explain.

> You are a new financial analyst working for a company that's more than 100 years old. The CFO has asked you and a young member of the accounting staff to work together in reviewing the firm's capital structure for the purpose of recalculating its cost o

> Why did credit default swaps make the crisis worse?

> Why are residuals important in negotiations between lessees and lessors?

> You are developing next year’s financial plan for Ajax Inc., a medium sized manufacturing company that’s currently operating at 80% of factory’s capacity. The firm is launching a sales promotion that’s expected to generate a sudden 20% increase in reven

> Just what is placed on the balance sheet in a financing lease?

> Define the idea of capital structure and capital components. Why is capital structure important to the cost of capital concept? In many capital structure discussions, preferred stock is lumped in with either debt or common equity. With respect to the cos

> Is the CAPM a true and accurate representation of the securities world?

> The CAPM purports to explain how management decisions about risk can influence the well-being of stockholders. Describe in words the mechanism through which this works.

> Explain the concepts of sovereign debt and a sovereign debt crisis. Why is such a crisis different for a Eurozone country than for a country with a unique currency.

> How is risk aversion reflected in the SML?

> How does the SML determine the price of a security?

> Describe the SML in words. What is it saying about how investors form required rates of return? Thoroughly evaluate the implications of the SML's message.

> Why is it appropriate to define the WACC as the highest step on the MCC under the IOS? Is anything lost by using this definition?

> After the break in the MCC caused by using up retained earnings, the schedule can be expected to remain flat indefinitely. Is this statement right or wrong? If wrong, explain what can be expected to happen to the MCC and why.

> Compare the cost of capital concept with the idea of the required return on a stock investment made by an individual. Relate both ideas to the risk of the investment. How would a very risky investment/ project be handled in the capital budgeting/cost o

> What is it about the cash flows associated with business projects that makes the NPV profile slope downward to the right? Would the NPV profile of any randomly selected set of positive and negative flows necessarily slope one way or the other? Why?

> Think about the cash flows associated with putting $100,000 in the bank for five years, assuming you draw out the interest each year and then close the account. Now think about a set of hypothetical cash flows associated with putting the same money in a

> Suppose the present value of cash ins and outs is very close to balance for a project to build a new $50M factory, so that the NPV is +$25,000. The same company is thinking about buying a new trailer truck for $150,000. The NPV of projected cash flows

> Projects A and B have approximately the same NPV. Their initial outlays are similar in size. Project A has early positive cash flows, and little or nothing is expected to come in later on. Project B has much larger positive cash flows than A, but they

> China refuses to allow its currency, the yuan, to float on international currency exchanges. Why is that a problem for the United States?

> Rationalize the appropriateness of using the cost of capital to analyze normally risky projects and higher rates for those with more risk.

> Give a verbal definition of risk that's consistent with the way we use the word in everyday life. Discuss the weaknesses of that definition for financial theory.

> One of the problems of using simulation to incorporate risk into capital budgeting is related to the idea that the probability distributions of successive cash flows usually are not independent. If the first period's cash flow is at the high end of its

> A random variable is defined as the outcome of one or more chance processes. Imagine that you're forecasting the cash flows associated with a new business venture. List some of the things that come together to produce cash flows in future periods. Descri

> Under what conditions will the IRR and NPV methods give conflicting results for mutually exclusive decisions? Will they ever give conflicting results for stand-alone decisions? Why?

> The following set of cash flows changes sign twice and has two IRR solutions. Identify the sign changes. Demonstrate mathematically that 25% and 400% are both solutions to the IRR equation. On the basis of this example, why would you expect multiple s

> In 1983 the Bell Telephone System, which operated as AT&T, was broken up resulting in the creation of seven regional telephone companies. AT&T stockholders received shares of the new companies and the continuing AT&T, which handled long distance service

> Explain the rationale behind the NPV method in your own words. Why is a higher NPV conceptually better than a lower one?

> Define and discuss (words only, no equations) the concepts of expected return and required return.

> Compare and contrast the nature of cash flows stemming from an investment in stock with those coming from bonds.

> Broadly define and describe globalization and its implications.

> The typical cash flow pattern for business projects involves cash outflows first, then inflows. However, it's possible to imagine a project in which the pattern is reversed. For example, we might receive inflows now in return for guarantying to make pa

> Define mutual exclusivity and describe ways in which projects can be mutually exclusive.