Question: Star, Inc., a prominent consumer products firm,

> What is homemade leverage?

> A project has an initial cost of I, has a required return of R, and pays C annually for N years. a. Find C in terms of I and N such that the project has a payback period just equal to its life. b. Find C in terms of I, N, and R such that this is a profit

> The Newton Company has 50,000 shares of stock that each sell for $40. Suppose the company issues 9,000 shares of new stock at the following prices: $40, $20, and $10. What is the effect of each of the alternative offering prices on the existing price per

> What is the primary difference between a warrant and a traded call option?

> In the previous problem, suppose the company instead decides on a five-for-one stock split. The firm’s 45 cent per share cash dividend on the new (postsplit) shares represents an increase of 10 percent over last year’s dividend on the presplit stock. Wha

> Bolero, Inc., has compiled the following information on its financing costs: The company is in the 35 percent tax bracket and has a target debt–equity ratio of 60 percent. The target short-term debt/long-term debt ratio is 20 percent.

> When personal taxes on interest income and bankruptcy costs are considered, the general expression for the value of a levered firm in a world in which the tax rate on equity distributions equals zero is: where: VL = The value of a levered firm. VU = The

> ABC Co. and XYZ Co. are identical firms in all respects except for their capital structure. ABC is all equity financed with $640,000 in stock. XYZ uses both stock and perpetual debt; its stock is worth $320,000 and the interest rate on its debt is 8 perc

> In the previous problem, suppose the company’s stock has a beta of 1.15. The risk-free rate is 3.7 percent, and the market risk premium is 7 percent. Assume that the overall cost of debt is the weighted average implied by the two outstanding debt issues.

> Assume that the following market model adequately describes the return-generating behavior of risky assets: Here: Rit = The return on the ith asset at Time t. RMt = The return on a portfolio containing all risky assets in some proportion at Time t. RMt a

> T-bills currently yield 3.9 percent. Stock in Nina Manufacturing is currently selling for $63 per share. There is no possibility that the stock will be worth less than $61 per share in one year. a. What is the value of a call option with a $60 exercise p

> Consider the following information: a. Your portfolio is invested 30 percent each in A and C, and 40 percent in B. What is the expected return of the portfolio? b. What is the variance of this portfolio? The standard deviation? Rate of Return if St

> You’ve observed the following returns on SkyNet Data Corporation’s stock over the past five years: 21 percent, 17 percent, 26 percent, 27 percent, and 4 percent. a. What was the arithmetic average return on the company’s stock over this five-year period?

> You are considering investing in a company that cultivates abalone for sale to local restaurants. Use the following information: The discount rate for the company is 15 percent, the initial investment in equipment is $840,000, and the projectâ&#1

> Howell Petroleum is considering a new project that complements its existing business. The machine required for the project costs $3.9 million. The marketing department predicts that sales related to the project will be $2.35 million per year for the next

> Why do companies issue options to executives if they cost the company more than they are worth to the executive? Why not just give cash and split the difference? Wouldn’t that make both the company and the executive better off?

> General Modems has five-year warrants that currently trade in the open market. Each warrant gives its owner the right to purchase one share of common stock for an exercise price of $55. a. Suppose the stock is currently trading for $51 per share. What is

> In the previous problem, assume that the exercise style on the option is American rather than European. What is the price of the option now? (Hint: How will you find the value of the option if it can be exercised early? When would you exercise the option

> The Wildcat Oil Company is trying to decide whether to lease or buy a new computer-assisted drilling system for its oil exploration business. Management has decided that it must use the system to stay competitive; it will provide $2.9 million in annual p

> The newspaper reported last week that Bennington Enterprises earned $29 million this year. The report also stated that the firm’s return on equity is 17 percent. Bennington retains 80 percent of its earnings. What is the firm’s earnings growth rate? What

> When should a firm force conversion of convertibles? Why?

> The yields on nonconvertible preferred stock are lower than the yields on corporate bonds. Why is there a difference? Which investors are the primary holders of preferred stock? Why?

> For initial public offerings of common stock, 2007 was a relatively slow year, with only about $35.6 billion raised by the process. Relatively few of the 159 firms involved paid cash dividends. Why do you think that most chose not to pay cash dividends?

> As was mentioned in the chapter, new equity issues are generally only a small portion of all new issues. At the same time, companies continue to issue new debt. Why do companies tend to issue little new equity but continue to issue new debt?

> Several celebrated investors and stock pickers frequently mentioned in the financial press have recorded huge returns on their investments over the past two decades. Does the success of these particular investors invalidate the EMH? Explain.

> Consider a levered firm’s projects that have similar risks to the firm as a whole. Is the discount rate for the projects higher or lower than the rate computed using the security market line? Why?

> What is data mining? Why might it overstate the relation between some stock attribute and returns?

> How is it possible that dividends are so important, but at the same time dividend policy is irrelevant?

> What rule should a firm follow when making financing decisions? How can firms create valuable financing opportunities?

> A broker has advised you not to invest in oil industry stocks because they have high standard deviations. Is the broker’s advice sound for a risk-averse investor like yourself? Why or why not?

> What is the difference between arithmetic and geometric returns? Suppose you have invested in a stock for the last 10 years. Which number is more important to you, the arithmetic or geometric return?

> An option can often have more than one source of value. Consider a logging company. The company can log the timber today or wait another year (or more) to log the timber. What advantages would waiting one year potentially have?

> A major college textbook publisher has an existing finance textbook. The publisher is debating whether to produce an “essentialized” version, meaning a shorter (and lower-priced) book. What are some of the considerations that should come into play?

> The investment in Project A is $1 million, and the investment in Project B is $2 million. Both projects have a unique internal rate of return of 20 percent. Is the following statement true or false? For any discount rate from 0 percent to 20 percent, Pro

> What are the three factors that determine a company’s price−earnings ratio?

> You own a callable, convertible bond with a conversion ratio of 25.18. The stock is currently selling for $47 per share. The issuer of the bond has announced a call at a call price of 110. What are your options here? What should you do?

> How does sensitivity analysis interact with break-even analysis?

> Why will convertible bonds not be voluntarily converted to stock before expiration?

> Your company currently uses traditional capital budgeting techniques, including net present value. After hearing about the use of real option analysis, your boss decides that your company should use real option analysis in place of net present value. How

> How is the APV of a project calculated?

> Suppose a certain stock currently sells for $30 per share. If a put option and a call option are available with $30 exercise prices, which do you think will sell for more? Explain.

> Ren-Stimpy International is planning to raise fresh equity capital by selling a large new issue of common stock. Ren-Stimpy is currently a publicly traded corporation, and it is trying to choose between an underwritten cash offer and a rights offering (n

> What are the advantages of using the SML approach to finding the cost of equity capital? What are the disadvantages? What are the specific pieces of information needed to use this method? Are all of these variables observable, or do they need to be estim

> Why is the use of debt financing referred to as financial “leverage”?

> Do you think preferred stock is more like debt or equity? Why?

> Critically evaluate the following statements: Playing the stock market is like gambling. Such speculative investing has no social value other than the pleasure people get from this form of gambling.

> How can the return on a portfolio be expressed in terms of a factor model?

> Suppose the following two independent investment opportunities are available to Relax, Inc. The appropriate discount rate is 8.5 percent. a. Compute the profitability index for each of the two projects. b. Which project(s) should the company accept bas

> Good Time Company is a regional chain department store. It will remain in business for one more year. The probability of a boom year is 60 percent and the probability of a recession is 40 percent. It is projected that the company will generate a total ca

> KIC, Inc., plans to issue $5 million of bonds with a coupon rate of 8 percent and 30 years to maturity. The current market interest rates on these bonds are 7 percent. In one year, the interest rate on the bonds will be either 10 percent or 6 percent wit

> If you can borrow all the money you need for a project at 6 percent, doesn’t it follow that 6 percent is your cost of capital for the project?

> Filer Manufacturing has 8.3 million shares of common stock outstanding. The current share price is $53, and the book value per share is $4. The company also has two bond issues outstanding. The first bond issue has a face value of $70 million and a coupo

> The Starr Co. just paid a dividend of $1.95 per share on its stock. The dividends are expected to grow at a constant rate of 4.5 percent per year, indefinitely. If investors require a return of 11 percent on the stock, what is the current price? What wil

> There are two stock markets, each driven by the same common force, F, with an expected value of zero and standard deviation of 10 percent. There are many securities in each market; thus, you can invest in as many stocks as you wish. Due to restrictions,

> Consider the following information: a. What is the expected return on an equally weighted portfolio of these three stocks? b. What is the variance of a portfolio invested 20 percent each in A and B, and 60 percent in C? State of Rate of

> Refer to Table 10.1(given below) in the text and look at the period from 1973 through 1978. a. Calculate the arithmetic average returns for large-company stocks and T-bills over this period. b. Calculate the standard deviation of the returns for large-

> B&B has a new baby powder ready to market. If the firm goes directly to the market with the product, there is only a 55 percent chance of success. However, the firm can conduct customer segment research, which will take a year and cost $950,000. By going

> An asset used in a four-year project falls in the five-year MACRS class for tax purposes. The asset has an acquisition cost of $8,300,000 and will be sold for $1,700,000 at the end of the project. If the tax rate is 35 percent, what is the aftertax salva

> There is a European put option on a stock that expires in two months. The stock price is $82, and the standard deviation of the stock returns is 70 percent. The option has a strike price of $90, and the risk-free interest rate is a 5 percent annual perce

> Quartz Corporation is a relatively new firm. Quartz has experienced enough losses during its early years to provide it with at least eight years of tax loss carryforwards. Thus, Quartz’s effective tax rate is zero. Quartz plans to lease equipment from Ne

> Raggio, Inc., has 145,000 shares of stock outstanding. Each share is worth $75, so the company’s market value of equity is $10,875,000. Suppose the firm issues 30,000 new shares at the following prices: $75, $70, and $65. What will the effect be of each

> The company with the common equity accounts shown here has declared a stock dividend of 15 percent when the market value of its stock is $57 per share. What effects on the equity accounts will the distribution of the stock dividend have? Common stoc

> Given that RadNet was up by about 411 per cent for 2014, why didn’t all investors hold RadNet?

> Given the choice, would a firm prefer to use MACRS depreciation or straight-line depreciation? Why?

> National Electric Company (NEC) is considering a $68 million project in its power systems division. Tom Edison, the company’s chief financial officer, has evaluated the project and determined that the project’s unlevered cash flows will be $4.4 million p

> Ayden, Inc., has an issue of preferred stock outstanding that pays a $4.50 dividend every year, in perpetuity. If this issue currently sells for $87 per share, what is the required return?

> Why might a firm choose to engage in a sale and leaseback transaction? Give two reasons.

> The DRK Corporation has recently developed a dividend reinvestment plan, or DRIP. The plan allows investors to reinvest cash dividends automatically in DRK in exchange for new shares of stock. Over time, investors in DRK will be able to build their holdi

> As mentioned in the text, some firms have filed for bankruptcy because of actual or likely litigation-related losses. Is this a proper use of the bankruptcy process?

> Under what circumstances would it be appropriate for a firm to use different costs of capital for its different operating divisions? If the overall firm WACC was used as the hurdle rate for all divisions, would the riskier divisions or the more conservat

> Consider the following quotation from a leading investment manager: “The shares of Southern Co. have traded close to $12 for most of the past three years. Since Southern’s stock has demonstrated very little price movement, the stock has a low beta. Texas

> Two years ago, the Lake Minerals and Small Town Furniture stock prices were the same. The average annual return for both stocks over the past two years was 10 percent. Lake Minerals’ stock price increased 10 percent each year. Small Town Furniture’s stoc

> U.S. Treasury bonds are not rated. Why? Often, junk bonds are not rated. Why?

> “When evaluating projects, we’re only concerned with the relevant incremental aftertax cash flows. Therefore, because depreciation is a noncash expense, we should ignore its effects when evaluating projects.” Critically evaluate this statement.

> Referring to the previous questions, under what circumstances might a company choose not to pay dividends?

> Is it true that a U.S. Treasury security is risk-free?

> Are the capital budgeting criteria we discussed applicable to not-for-profit corporations? How should such entities make capital budgeting decisions? What about the U.S. government? Should it evaluate spending proposals using these techniques?

> In the context of the dividend growth model, is it true that the growth rate in dividends and the growth rate in the price of the stock are identical?

> Companies pay rating agencies such as Moody’s and S&P to rate their bonds, and the costs can be substantial. However, companies are not required to have their bonds rated in the first place; doing so is strictly voluntary. Why do you think they do it?

> True or false: The unsystematic risk of a share of stock is irrelevant for valuing the stock because it can be diversified away; therefore, it is also irrelevant for valuing a call option on the stock. Explain.

> Zipcar, the car sharing company, went public in April 2011. Assisted by the investment bank Goldman Sachs, Zipcar sold 9.68 million shares at $18 each, thereby raising a total of $174.24 million. By the end of the first day of trading, the stock had zipp

> Last month, Central Virginia Power Company, which had been having trouble with cost overruns on a nuclear power plant that it had been building, announced that it was “temporarily suspending dividend payments due to the cash flow crunch associated with i

> What is a proxy?

> What are the implications of the efficient market hypothesis for investors who buy and sell stocks in an attempt to “beat the market”?

> What is the relationship between the one-factor model and the CAPM?

> A coworker claims that looking at so much marginal this and incremental that is just a bunch of nonsense, and states, “Listen, if our average revenue doesn’t exceed our average cost, then we will have a negative cash flow, and we will go broke!” How do y

> Bill plans to open a self-serve grooming center in a storefront. The grooming equipment will cost $265,000, to be paid immediately. Bill expects aftertax cash inflows of $59,000 annually for seven years, after which he plans to scrap the equipment and re

> What is forecasting risk? In general, would the degree of forecasting risk be greater for a new product or a cost-cutting proposal? Why?

> Agency Costs Fountain Corporation’s economists estimate that a good business environment and a bad business environment are equally likely for the coming year. The managers of the company must choose between two mutually exclusive proje

> Ignoring taxes in Problem 6, what is the price per share of equity under Plan I? Plan II? What principle is illustrated by your answers?

> Harrison, Inc., has the following book value balance sheet: a. What is the debt–equity ratio based on book values? b. Suppose the market value of the company’s debt is $225 million and the market value of equity is $

> Fama’s Llamas has a weighted average cost of capital of 9.8 percent. The company’s cost of equity is 13 percent, and its cost of debt is 6.5 percent. The tax rate is 35 percent. What is Fama’s debt–equity ratio?

> You are forming an equally weighted portfolio of stocks. Many stocks have the same beta of .84 for Factor 1 and the same beta of 1.69 for Factor 2. All stocks also have the same expected return of 11 percent. Assume a two-factor model describes the retur

> A portfolio is invested 20 percent in Stock G, 55 percent in Stock J, and 25 percent in Stock K. The expected returns on these stocks are 9 percent, 11 percent, and 14 percent, respectively. What is the portfolio’s expected return? How do you interpret y

> Using the following returns, calculate the average returns, the variances, and the standard deviations for X and Y: Returns Year Y 9% 12% 2 21 27 3 -27 -32 4 15 14 5 23 36

> You find a zero coupon bond with a par value of $10,000 and 17 years to maturity. If the yield to maturity on this bond is 4.9 percent, what is the dollar price of the bond? Assume semiannual compounding periods.

> Suppose you are evaluating a callable, convertible bond. If the stock price volatility increases, how will this affect the price of the bond?

> The manager for a growing firm is considering the launch of a new product. If the product goes directly to market, there is a 50 percent chance of success. For $125,000 the manager can conduct a focus group that will increase the product’s chance of succ

> Dog Up! Franks is looking at a new sausage system with an installed cost of $345,000. This cost will be depreciated straight-line to zero over the project’s five-year life, at the end of which the sausage system can be scrapped for $25,000. The sausage s

> Maxwell Software, Inc., has the following mutually exclusive projects. a. Suppose the company’s payback period cutoff is two years. Which of these two projects should be chosen? b. Suppose the company uses the NPV rule to rank these t