Question: Six-month T-bills have a nominal

> Austin Grocers recently reported the following 2008 income statement (in millions of dollars): This year the company is forecasting a 25% increase in sales; and it expects that its year-end operating costs, including depreciation, will equal 70% of sale

> Refer to Problem 17-1. What additional funds would be needed if the company’s year-end 2008 assets had been $4 million? Assume that all other numbers are the same. Why is this AFN different from the one you found in Problem 17-1? Is the company’s “capita

> Companies often have to increase their initial investment costs to obtain real options. Why might this be so, and how could a firm decide if it was worth the cost to obtain a given real option?

> Microtech Corporation is expanding rapidly and currently needs to retain all of its earnings; hence, it does not pay dividends. However, investors expect Microtech to begin paying dividends, beginning with a dividend of $1.00 coming 3 years from today. T

> Primrose Corp has $15 million of sales, $2 million of inventories, $3 million of receivables, and $1 million of payables. Its cost of goods sold is 80% of sales, and it finances working capital with bank loans at an 8% rate. What is Primrose’s cash conve

> McDowell Industries sells on terms of 3/10, net 30. Total sales for the year are $912,500; 40% of the customers pay on the 10th day and take discounts, while the other 60% pay, on average, 40 days after their purchases. a. What is the days’ sales outstan

> Dan Barnes, financial manager of Ski Equipment Inc. (SKI), is excited, but apprehensive. The company’s founder recently sold his 51% controlling block of stock to Kent Koren, who is a big fan of EVA (Economic Value Added). EVA is found

> Digital Inc. is considering production of a new cell phone. The project will require an investment of $20 million. If the phone is well-received, the project will produce cash flows of $10 million a year for 3 years; but if the market does not like the p

> Rework Problem 16-10 using a spreadsheet model. After completing Parts a through d, respond to the following: If Bowers’ customers began to pay late, collections would slow down, thus increasing the required loan amount. If sales declin

> Indicate whether each of the following actions will increase or decrease a bond’s yield to maturity: a. The bond’s price increases. b. The bond is downgraded by the rating agencies. c. A change in the bankruptcy code makes it more difficult for bondhold

> The cost of retained earnings is less than the cost of new outside equity capital. Consequently, it is totally irrational for a firm to sell a new issue of stock and to pay dividends during the same year. Discuss the meaning of those statements.

> Discuss the pros and cons of having the directors formally announce what a firm’s dividend policy will be in the future.

> Indicate whether the following statements are true or false. If the statement is false, explain why. a. If a firm repurchases its stock in the open market, the shareholders who tender the stock are subject to capital gains taxes. b. If you own 100 shares

> Suppose you won the lottery and had two options: (1) Receiving $0.5 million or (2)Taking a gamble in which at the flip of a coin you receive $1 million if a head comes up but receive zero if a tail comes up. a. What is the expected value of the gamble?

> Buena Terra Corporation is reviewing its capital budget for the upcoming year. It has paid a $3.00 dividend per share (DPS) for the past several years, and its shareholders expect the dividend to remain constant for the next several years. The company’s

> One alleged advantage of leasing voiced in the past was that it kept liabilities off the balance sheet, thus making it possible for a firm to obtain more leverage than it otherwise could have. This raised the question of whether the lease obligation and

> Distinguish between operating leases and financial leases. Would a firm be more likely to finance a fleet of trucks or a manufacturing plant with an operating lease? Explain.

> One often finds that a company’s bonds have a higher yield than its preferred stock even though an investor considers the bonds to be less risky than the preferred. What causes this yield differential?

> Kaufman Enterprises has bonds outstanding with a $1,000 face value and 10 years left until maturity. They have an 11% annual coupon payment, and their current price is $1,175. The bonds may be called in 5 years at 109% of face value (Call price = $1,090)

> Suppose interest rates on Treasury bonds rose from 5% to 9% as a result of higher interest rates in Europe. What effect would this have on the price of an average company’s common stock?

> You are told that one corporation just issued $100 million of preferred stock and another purchased $100 million of preferred stock as an investment. You are also told that one firm has an effective tax rate of 20%, whereas the other is in the 35% bracke

> For purposes of measuring a firm’s leverage, should preferred stock be classified as debt or equity? Does it matter if the classification is being made (a) By the firm’s management, (b) By creditors, or (c) By equity investors?

> Assume that you have just been hired as business manager of Campus Deli (CD), which is located adjacent to the campus. Sales were $1,100,000 last year, variable costs were 60% of sales, and fixed costs were $40,000. Therefore, EBIT totaled $400,000. Beca

> Suppose a company simultaneously issues $50 million of convertible bonds with a coupon rate of 9% and $50 million of pure bonds with a coupon rate of 12%. Both bonds have the same maturity. Does the fact that the convertible issue has the lower coupon ra

> a. How would a firm’s decision to pay out a higher percentage of its earnings as dividends affect each of the following? (1) The value of its long-term warrants (2) The likelihood that its convertible bonds will be converted (3) The likelihood that its w

> What effect does the expected growth rate of a firm’s stock price (subsequent to issue) have on its ability to raise additional funds through (a) Convertibles and (b) Warrants?

> Suppose Congress changed the tax laws in a way that (1) Permitted equipment to be depreciated over a shorter period, (2) Lowered corporate tax rates, and (3) Reinstated the investment tax credit. Discuss how each of these changes would affect the rela

> Suppose there were no IRS restrictions on what constitutes a valid lease. Explain in a manner that a legislator might understand why some restrictions should be imposed.

> Pogue Industries Inc. has warrants outstanding that permit its holders to purchase 1 share of stock per warrant at a price of $21. (Refer to Chapter 18 for Parts a, b, and c.) a. Calculate the exercise value of Pogue’s warrants if the common stock sells

> Morris-Meyer Mining Company must install $1.5 million of new machinery in its Nevada mine. It can obtain a bank loan for 100% of the required amount. Alternatively, a Nevada investment banking firm that represents a group of investors believes that it ca

> Two textile companies, McDaniel-Edwards Manufacturing and Jordan-Hocking Mills, began operations with identical balance sheets. A year later both required additional manufacturing capacity at a cost of $200,000. McDaniel-Edwards obtained a 5-year, $200,0

> Look back at Table 7-4 and examine United Parcel Service and Telecom Italia Capital bonds that mature in 2013. a. If these companies were to sell new $1,000 par value long-term bonds, approximately what coupon interest rate would they have to set if they

> Gregg Company recently issued two types of bonds. The first issue consisted of 20-year straight (no warrants attached) bonds with an 8% annual coupon. The second issue consisted of 20-year bonds with a 6% annual coupon with warrants attached. Both bonds

> Elliott Athletics is trying to determine its optimal capital structure, which now consists of only debt and common equity. The firm does not currently use preferred stock in its capital structure, and it does not plan to do so in the future. Its treasury

> Connors Construction needs a piece of equipment that can be leased or purchased. The equipment costs $100. One option is to borrow $100 from the local bank and use the money to buy the equipment. The other option is to lease the equipment. If Connors cho

> O’Brien Computers Inc. needs to raise $35 million to begin producing a new microcomputer. O’Brien’s straight, nonconvertible debentures currently yield 12%. Its stock sells for $38 per share, the last dividend was $2.46, and the expected growth rate is a

> The Howe Computer Company has grown rapidly during the past 5 years. Recently, its commercial bank urged the company to consider increasing its permanent financing. Its bank loan under a line of credit has risen to $150,000, carrying a 10% interest rate,

> As part of its overall plant modernization and cost reduction program, the management of Tanner-Woods Textile Mills has decided to install a new automated weaving loom. In the capital budgeting analysis of this equipment, the IRR of the project was found

> In the summer of 2008, the Hadaway Company was planning to finance an expansion with a convertible security. They considered a convertible debenture but feared the burden of fixed interest charges if the common stock did not rise enough to make conversio

> Martha Millon, financial manager of Fish & Chips Inc., is facing a dilemma. The firm was founded 5 years ago to develop a new fast-food concept; and although Fish & Chips has done well, the firm’s founder and chairman believes that an industry shake-out

> Martha Millon, financial manager for Fish & Chips Inc., has been asked to perform a lease versus- buy analysis on a new computer system. The computer costs $1,200,000; and if it is purchased, Fish & Chips could obtain a term loan for the full amount at a

> Storm Software wants to issue $100 million in new capital to fund new opportunities. If Storm raised the $100 million of new capital in a straight-debt 20-year bond offering, Storm would have to offer an annual coupon rate of 12%. However, Storm’s advise

> Use the spreadsheet model to rework Parts a and b of Problem 20-8. Then answer the following question. c. Accepting that the corporate WACC should be used equally to discount all anticipated cash flows, at what cost of capital would the firm be indiffere

> Last year Joan purchased a $1,000 face value corporate bond with an 11% annual coupon rate and a 10-year maturity. At the time of the purchase, it had an expected yield to maturity of 9.79%. If Joan sold the bond today for $1,060.49, what rate of return

> Would a failure to recognize growth options tend to cause a firm’s actual capital budget to be above or below the optimal level? Would your answer be the same for abandonment, timing, and flexibility options? Explain.

> Should firms require higher rates of return on foreign projects than on identical projects located at home? Explain.

> What is a Eurodollar? If a French citizen deposits $10,000 in Chase Manhattan Bank in New York, have Eurodollars been created? What if the deposit is made in Barclay’s Bank in London? Chase Manhattan’s Paris branch? Does the existence of the Eurodollar m

> Why might purchasing power parity fail to hold?

> Does interest rate parity imply that interest rates are the same in all countries?

> A currency trader observes that in the spot exchange market, 1 U.S. dollar can be exchanged for 3.50 Israeli shekels or for 104.00 Japanese yen. What is the cross exchange rate between the yen and the shekel; that is, how many yen would you receive for e

> Solitaire Machinery is a Swiss multinational manufacturing company. Currently, Solitaire’s financial planners are considering undertaking a 1-year project in the United States. The project’s expected dollar-denominated cash flows consist of an initial in

> After all foreign and U.S. taxes, a U.S. corporation expects to receive 3 pounds of dividends per share from a British subsidiary this year. The exchange rate at the end of the year is expected to be $2 per pound, and the pound is expected to depreciate

> You are the vice president of International InfoXchange, headquartered in Chicago, Illinois. All shareholders of the firm live in the United States. Earlier this month you obtained a loan of 5 million Canadian dollars from a bank in Toronto to finance th

> Chamberlain Canadian Imports has agreed to purchase 15,000 cases of Canadian beer for 4 million Canadian dollars at today’s spot rate. The firm’s financial manager, James Churchill, has noted the following current spot

> Explain in general terms what each of the following real options is and how it could change projects’ NPVs and their corresponding risk relative to what would have been estimated if the options had not been considered. a. abandonment b. timing c. growth

> You are considering a 10-year, $1,000 par value bond. Its coupon rate is 9%, and interest is paid semiannually. If you require an “effective” annual interest rate (not a nominal rate) of 8.16%, how much should you be willing to pay for the bond?

> Assume that interest rate parity holds and that 90-day risk-free securities yield 5% in the United States and 5.3% in Britain. In the spot market, 1 pound ¼ $2. a. Is the 90-day forward rate trading at a premium or a discount relative to the spot rate? b

> Assume that interest rate parity holds. In both the spot market and the 90-day forward market, 1 Japanese yen = 0.0086 dollar. And 90-day risk-free securities yield 4.6% in Japan. What is the yield on 90-day risk-free securities in the United States?

> Use the foreign exchange section of a current issue of The Wall Street Journal to look up the three currencies in Problem 19-8. What is the current exchange rate between Swedish kronas and pounds? Data from Problem 19-8 Suppose the exchange rate between

> Use the foreign exchange section of a current issue of The Wall Street Journal to look up the six currencies in Problem 19-5. a. What is the current exchange rate for changing dollars into 1,000 units of pounds, Canadian dollars, euros, yen, Mexican peso

> Table 19-1 lists foreign exchange rates for May 26, 2008. On that day, how many dollars would be required to purchase 1,000 units of each of the following: British pounds, Canadian dollars, EMU euros, Japanese yen, Mexican pesos, and Swedish kronas? Tabl

> Citrus Products Inc. is a medium-sized producer of citrus juice drinks with groves in Indian River County, Florida. Until now, the company has confined its operations and sales to the United States; but its CEO, George Gaynor, wants to expand into the Pa

> Yohe Telecommunications is a multinational corporation that produces and distributes telecommunications technology. Although its corporate headquarters are located in Maitland, Florida, Yohe usually buys its raw materials in several different foreign cou

> Discuss some of the techniques available to reduce risk exposure.

> Why do options typically sell at prices higher than their exercise values?

> What is a post-audit, why do firms use them, and what problems can arise when they are used?

> List seven reasons risk management might increase the value of a firm.

> Bond X is non callable and has 20 years to maturity, a 9% annual coupon, and a $1,000 par value. Your required return on Bond X is 10%; and if you buy it, you plan to hold it for 5 years. You (and the market) have expectations that in 5 years, the yield

> Give two reasons stockholders might be indifferent between owning the stock of a firm with volatile cash flows and the stock of a firm with stable cash flows.

> How can swaps be used to reduce the risks associated with debt contracts?

> Explain how the futures markets can be used to reduce interest rate and input price risk.

> Assume that you have been given the following information on Purcell Industries: Using the Black-Scholes Option Pricing Model, what is the value of the option? Current stock price = $15 Exercise price of option = $15 Time to maturity of option = 6 m

> Which of the following events are likely to increase the market value of a call option on a common stock? Explain. a. An increase in the stock’s price b. An increase in the volatility of the stock price c. An increase in the risk-free rate d. A decrease

> Stewart Enterprises’ current stock price is $60 per share. Call options for this stock exist that permit the holder to purchase one share at an exercise price of $50. These options will expire at the end of 1 year, at which time Stewart’s stock will be s

> Audrey is considering an investment in Morgan Communications, whose stock currently sells for $60. A put option on Morgan’s stock, with an exercise price of $55, has a market value of $3.06. Meanwhile, a call option on the stock with the same exercise pr

> The Zinn Company plans to issue $20,000,000 of 10-year bonds in December to help finance a new research and development laboratory. It is now August, and the current cost of debt to the high-risk biotech company is 11%. However, the firmâ€&#15

> How might a firm’s corporate WACC be affected by the size of its capital budget?

> 21st Century Educational Products (21st Century) is a rapidly growing software company; and consistent with its growth, it has a relatively large capital budget. While most of the company’s projects are fairly easy to evaluate, a handfu

> Bankers’ Services Inc. (BSI) is considering a project that has a cost of $10 million and an expected life of 3 years. There is a 30% probability of good conditions, in which case the project will provide a cash flow of $9 million at the end of each year

> What are some differences in the analysis for a replacement project versus that for a new expansion project?

> Most firms generate cash inflows every day, not just once at the end of the year. In capital budgeting, should we recognize this fact by estimating daily project cash flows and then using them in the analysis? If we do not, are our results biased? If so,

> Suppose you believe that the economy is just entering a recession. Your firm must raise capital immediately, and debt will be used. Should you borrow on a long-term or a short term basis? Why?

> Explain why working capital is included in a capital budgeting analysis and how it is recovered at the end of a project’s life.

> Explain why sunk costs should not be included in a capital budgeting analysis but opportunity costs and externalities should be included. Give an example of each.

> What is a “replacement chain?” When and how should replacement chains be used in capital budgeting?

> If you were the CFO of a company that had to decide on hundreds of potential projects every year, would you want to use sensitivity analysis and scenario analysis as described in the chapter or would the amount of arithmetic required take too much time a

> Define (a) Sensitivity analysis, (b) Scenario analysis, and (c) Simulation analysis. If GE was considering two projects (one for $500 million to develop a satellite communications system and the other for a $30,000 new truck) on which project would th

> In theory, market risk should be the only “relevant” risk. However, companies focus as much on stand-alone risk as on market risk. What are the reasons for the focus on stand-alone risk?

> Distinguish among beta (or market) risk, within-firm (or corporate) risk, and stand-alone risk for a project being considered for inclusion in a firm’s capital budget.

> The Butler-Perkins Company (BPC) must decide between two mutually exclusive projects. Each costs $6,750 and has an expected life of 3 years. Annual project cash flows begin 1 year after the initial investment and are subject to the following probability

> Mississippi River Shipyards is considering replacing an 8-year-old riveting machine with a new one that will increase earnings before depreciation from $27,000 to $54,000 per year. The new machine will cost $82,500, and it will have an estimated life of

> The Dauten Toy Corporation uses an injection molding machine that was purchased 2 years ago. This machine is being depreciated on a straight-line basis, and it has 6 years of remaining life. Its current book value is $2,100, and it can be sold for $2,500

> In late 1980, the U.S. Commerce Department released new data showing inflation was 15%. At the time, the prime rate of interest was 21%, a record high. However, many investors expected the new Reagan administration to be more effective in controlling inf

> You must evaluate a proposal to buy a new milling machine. The base price is $108,000, and shipping and installation costs would add another $12,500. The machine falls into the MACRS 3-year class, and it would be sold after 3 years for $65,000. The appli

> You must evaluate a proposed spectrometer for the R&D Department. The base price is $140,000, and it would cost another $30,000 to modify the equipment for special use by the firm. The equipment falls into the MACRS 3-year class and would be sold after 3

> Kristin is evaluating a capital budgeting project that should last 4 years. The project requires $800,000 of equipment. She is unsure what depreciation method to use in her analysis, straight-line or the 3-year MACRS accelerated method. Under straight-li

> Corcoran Consulting is deciding which of two computer systems to purchase. It can purchase state-of-the-art equipment (System A) for $20,000, which will generate cash flows of $6,000 at the end of each of the next 6 years. Alternatively, the company can

> The Chang Company is considering the purchase of a new machine to replace an obsolete one. The machine being used for the operation has a book value and a market value of zero. However, the machine is in good working order and will last at least another

> Eisenhower Communications is trying to estimate the first-year net cash flow (at Year 1) for a proposed project. The financial staff has collected the following information on the project: The company has a 40% tax rate, and its WACC is 10%. a. What is

> Truman Industries is considering an expansion. The necessary equipment would be purchased for $9 million, and the expansion would require an additional $3 million investment in working capital. The tax rate is 40%. a. What is the initial investment outla