Your company currently produces and sells steel shaft golf clubs. The board of directors wants you to consider the introduction of a new line of titanium bubble woods with graphite shafts. Which of the following costs are not relevant? a. Land you already own that will be used for the project, but otherwise will be sold for $700,000, its market value. b. A $300,000 drop in your sales of steel shaft clubs if the titanium woods with graphite shafts are introduced. c. $200,000 spent on research and development last year on graphite shafts.
> Vital Silence, Inc., has a project with the following cash flows: The company evaluates all projects by applying the IRR rule. If the appropriate interest rate is 9 percent, should the company accept the project? Year Cash Flows ($) -$24,000 9,700
> The balance sheet for Levy Corp. is shown here in market value terms. There are 14,000 shares of stock outstanding. The company has declared a dividend of $1.60 per share. The stock goes ex dividend tomorrow. Ignoring any tax effects, what is the stock
> North Pole Fishing Equipment Corporation and South Pole Fishing Equipment Corporation would have identical equity betas of 1.10 if both were all equity financed. The market value information for each company is shown here: The expected return on the ma
> Edwards Construction currently has debt outstanding with a market value of $75,000 and a cost of 9 percent. The company has EBIT of $6,750 that is expected to continue in perpetuity. Assume there are no taxes. a. What is the value of the company’s equity
> In Problem 4, use MM Proposition I to find the price per share of equity under each of the two proposed plans. What is the value of the firm? Problem 4: Franklin Corporation is comparing two different capital structures, an all-equity plan (Plan I) and
> Kiedis, Corp., has interest-bearing debt with a market value of $65 million. The company also has 2 million shares that sell for $25 per share. What is the debt–equity ratio for this company based on market values?
> Suppose stock returns can be explained by a two-factor model. The firm-specific risks for all stocks are independent. The following table shows the information for two diversified portfolios: If the risk-free rate is 4 percent, what are the risk premiu
> Based on the following information, calculate the expected return and standard deviation for the two stocks: Probability of State of Economy State of Rate of Return if State Occurs Economy Stock A Stock B Recession .30 .06 -.20 Normal .55 .07 .13 Boo
> Even though most corporate bonds in the United States make coupon payments semiannually, bonds issued elsewhere often have annual coupon payments. Suppose a German company issues a bond with a par value of €1,000, 15 years to maturity, and a coupon rate
> With regard to bid and ask prices on a Treasury bond, is it possible for the bid price to be higher? Why or why not?
> Suppose a stock had an initial price of $64 per share, paid a dividend of $1.20 per share during the year, and had an ending share price of $73. Compute the percentage total return.
> Your company is deciding whether to invest in a new machine. The new machine will increase cash flow by $530,000 per year. You believe the technology used in the machine has a 10-year life; in other words, no matter when you purchase the machine, it will
> In the previous problem, suppose the fixed asset actually falls into the three-year MACRS class. All the other facts are the same. What is the project’s Year 1 net cash flow now? Year 2? Year 3? What is the new NPV?
> A warrant gives its owner the right to purchase three shares of common stock at an exercise price of $64 per share. The current market price of the stock is $68. What is the minimum value of the warrant?
> Jet Black is an international conglomerate with a petroleum division and is currently competing in an auction to win the right to drill for crude oil on a large piece of land in one year. The current market price of crude oil is $103 per barrel, and the
> The price of Tara, Inc., stock will be either $50 or $70 at the end of the year. Call options are available with one year to expiration. T-bills currently yield 5 percent. a. Suppose the current price of the stock is $62. What is the value of the call op
> You work for a nuclear research laboratory that is contemplating leasing a diagnostic scanner (leasing is a common practice with expensive, high-tech equipment). The scanner costs $5,800,000, and it would be depreciated straight-line to zero over four ye
> The St. Anger Corporation needs to raise $55 million to finance its expansion into new markets. The company will sell new shares of equity via a general cash offering to raise the needed funds. If the offer price is $32 per share and the company’s underw
> What is dilution, and why does it occur when warrants are exercised?
> Discuss the accounting criteria for determining whether a lease must be reported on the balance sheet. In each case give a rationale for the criterion.
> An investment project has annual cash inflows of $5,000, $5,500, $6,000, and $7,000, and a discount rate of 12 percent. What is the discounted payback period for these cash flows if the initial cost is $8,000? What if the initial cost is $12,000? What if
> What are the two types of risk that are measured by a levered beta?
> The following figures present the results of four cumulative abnormal returns (CAR) studies. Indicate whether the results of each study support, reject, or are inconclusive about the semistrong form of the efficient market hypothesis. In each figure, Tim
> Shanken Corp. issued a 30-year, 5.9 percent semiannual bond 6 years ago. The bond currently sells for 108 percent of its face value. The company’s tax rate is 35 percent. a. What is the pretax cost of debt? b. What is the aftertax cost of debt? c. Which
> Suppose a factor model is appropriate to describe the returns on a stock. The current expected return on the stock is 10.5 percent. Information about those factors is presented in the following chart: a. What is the systematic risk of the stock return?
> Rework Problems 1 and 2 assuming the ending share price is $57.
> Watters Umbrella Corp. issued 15-year bonds 2 years ago at a coupon rate of 5.9 percent. The bonds make semiannual payments. If these bonds currently sell for 105 percent of par value, what is the YTM?
> In each of the following cases, find the unknown variable. Ignore taxes. Accounting Break-Even Unit Variable Unit Price Cost Fixed Costs Depreciation 86,300 $ 42 $30 $ 820,000 143,806 81 2,750,000 $1,150,000 7,835 97 235,000 105,000
> Down Under Boomerang, Inc., is considering a new three- year expansion project that requires an initial fixed asset investment of $1.65 million. The fixed asset will be depreciated straight-line to zero over its three-year tax life, after which it will b
> Eckely, Inc., recently issued bonds with a conversion ratio of 14.5. If the stock price at the time of the bond issue was $53.16, what was the conversion premium?
> Gasworks, Inc., has been approached to sell up to 5 million gallons of gasoline in three months at a price of $2.65 per gallon. Gasoline is currently selling on the wholesale market at $2.34 per gallon and has a standard deviation of 62 percent. If the r
> Use the option quote information shown here to answer the questions that follow. The stock is currently selling for $114. a. Suppose you buy 10 contracts of the February 110 call option. How much will you pay, ignoring commissions? b. In part (a), supp
> What is the price of a 15-year, zero coupon bond paying $1,000 at maturity, assuming semiannual compounding, if the YTM is: a. 6 percent? b. 8 percent? c. 10 percent?
> What is a call option? A put option? Under what circumstances might you want to buy each? Which one has greater potential profit? Why?
> You work for a nuclear research laboratory that is contemplating leasing a diagnostic scanner (leasing is a common practice with expensive, high-tech equipment). The scanner costs $5,800,000, and it would be depreciated straight-line to zero over four ye
> Stone Shoe Co. has concluded that additional equity financing will be needed to expand operations and that the needed funds will be best obtained through a rights offering. It has correctly determined that as a result of the rights offering, the share pr
> For the company in Problem 2, show how the equity accounts will change if: a. The company declares a four-for-one stock split. How many shares are outstanding now? What is the new par value per share? b. The company declares a one-for-five reverse stock
> For the company in the previous problem, what is the dividend yield? What is the expected capital gains yield?
> Define each of the following investment rules and discuss any potential shortcomings of each. In your definition, state the criterion for accepting or rejecting independent projects under each rule. a. Payback period. b. Internal rate of return. c. Profi
> What is the difference between an American option and a European option?
> What are some of the potential problems with looking at IRRs when evaluating a leasing decision?
> It is sometimes suggested that firms should follow a “residual” dividend policy. With such a policy, the main idea is that a firm should focus on meeting its investment needs and maintaining its desired debt−equity ratio. Having done so, a firm pays out
> Due to large losses incurred in the past several years, a firm has $2 billion in tax loss carryforwards. This means that the next $2 billion of the firm’s income will be free from corporate income taxes. Security analysts estimate that it will take many
> How does the existence of financial distress costs and agency costs affect Modigliani and Miller’s theory in a world where corporations pay taxes?
> In a world with no taxes, no transaction costs, and no costs of financial distress, is the following statement true, false, or uncertain? Moderate borrowing will not increase the required return on a firm’s equity. Explain.
> What are the key differences between leasing and borrowing? Are they perfect substitutes?
> Preferred stock doesn’t offer a corporate tax shield on the dividends paid. Why do we still observe some firms issuing preferred stock?
> Which of the following statements are true about the efficient market hypothesis? a. It implies perfect forecasting ability. b. It implies that prices reflect all available information. c. It implies an irrational market. d. It implies that prices do not
> David McClemore, the CFO of Ultra Bread, has decided to use an APT model to estimate the required return on the company’s stock. The risk factors he plans to use are the risk premium on the stock market, the inflation rate, and the price of wheat. Becaus
> Suppose a project has conventional cash flows and a positive NPV. What do you know about its payback? Its discounted payback? Its profitability index? It’s IRR? Explain.
> A substantial percentage of the companies listed on the NYSE and the NASDAQ don’t pay dividends, but investors are nonetheless willing to buy shares in them. How is this possible given your answer to the previous question?
> You work for a nuclear research laboratory that is contemplating leasing a diagnostic scanner (leasing is a common practice with expensive, high-tech equipment). The scanner costs $5,800,000, and it would be depreciated straight-line to zero over four ye
> A convertible bond with a par value of $1,000 has a conversion price of $72.45. What is the conversion ratio of the bond?
> Explain what is meant by business and financial risk. Suppose Firm A has greater business risk than Firm B. Is it true that Firm A also has a higher cost of equity capital? Explain.
> What is the essential difference between sensitivity analysis and scenario analysis?
> What are the two options that many businesses have?
> In the aggregate, debt offerings are much more common than equity offerings and typically much larger as well. Why?
> Taxes are an important consideration in the leasing decision. Which is more likely to lease: A profitable corporation in a high tax bracket or a less profitable one in a low tax bracket? Why?
> A corollary to the Rule of 72 is the Rule of 69.3. The Rule of 69.3 is exactly correct except for rounding when interest rates are compounded continuously. Prove the Rule of 69.3 for continuously compounded interest.
> A useful rule of thumb for the time it takes an investment to double with discrete compounding is the “Rule of 72.” To use the Rule of 72, you simply divide 72 by the interest rate to determine the number of periods it takes for a value today to double.
> What is the equation for the present value of a growing perpetuity with a payment of C one period from today if the payments grow by C each period?
> A check-cashing store is in the business of making personal loans to walk-up customers. The store makes only one-week loans at 6.5 percent interest per week. a. What APR must the store report to its customers? What is the EAR that the customers are actua
> As discussed in the text, an annuity due is identical to an ordinary annuity except that the periodic payments occur at the beginning of each period and not at the end of the period. Show that the relationship between the value of an ordinary annuity and
> What is the value of an investment that pays $50,000 every other year forever, if the first payment occurs one year from today and the discount rate is 13 percent compounded daily? What is the value today if the first payment occurs four years from today
> What are the main differences between corporate debt and equity? Why do some firms try to issue equity in the guise of debt?
> Your financial planner offers you two different investment plans. Plan X is a $20,000 annual perpetuity. Plan Y is a 10-year, $34,000 annual annuity. Both plans will make their first payment one year from today. At what discount rate would you be indiffe
> J. Smythe, Inc., manufactures fine furniture. The company is deciding whether to introduce a new mahogany dining room table set. The set will sell for $6,100, including a set of eight chairs. The company feels that sales will be 1,900, 2,250, 2,700, 2,45
> You purchase one call and sell one put with the same strike price and expiration date. What is the delta of your portfolio? Why?
> Assume Stocks A and B have the following characteristics: The covariance between the returns on the two stocks is .001. a. Suppose an investor holds a portfolio consisting of only Stock A and Stock B. Find the portfolio weights, X A and X B, such that
> What is the impact of a stock repurchase on a company’s debt ratio? Does this suggest another use for excess cash?
> After extensive medical and marketing research, Pill, Inc., believes it can penetrate the pain reliever market. It is considering two alternative products. The first is a medication for headache pain. The second is a pill for headache and arthritis pain.
> A stock is currently priced at $50. The stock will never pay a dividend. The risk-free rate is 12 percent per year, compounded continuously, and the standard deviation of the stock’s return is 60 percent. A European call option on the stock has a strike
> There are two stocks in the market, Stock A and Stock B. The price of Stock A today is $75. The price of Stock A next year will be $64 if the economy is in a recession, $87 if the economy is normal, and $97 if the economy is expanding. The probabilities
> O’Bannon Electronics has an investment opportunity to produce a new HDTV. The required investment on January 1 of this year is $145 million. The firm will depreciate the investment to zero using the straight-line method over four years.
> Put Pricing Model Use the Black–Scholes model for pricing a call, put–call parity, and the previous question to show that the Black–Scholes model for directly pricing a put can be written as follows:
> How do you determine the appropriate cost of debt for a company? Does it make a difference if the company’s debt is privately placed as opposed to being publicly traded? How would you estimate the cost of debt for a firm whose only debt issues are privat
> Suppose you observe the following situation: a. Calculate the expected return on each stock. b. Assuming the capital asset pricing model holds and Stock A’s beta is greater than Stock B’s beta by .25, what is the exp
> The Biological Insect Control Corporation (BICC) has hired you as a consultant to evaluate the NPV of its proposed toad ranch. The company plans to breed toads and sell them as ecologically desirable insect control mechanisms. They anticipate that the bu
> In the chapter we noted that the delta for a put option is N(d1) − 1. Is this the same thing as −N(−d1)? (Hint: Yes, but why?)
> There are three securities in the market. The following chart shows their possible payoffs: a. What are the expected return and standard deviation of each security? b. What are the covariances and correlations between the pairs of securities? c. What a
> Paul Adams owns a health club in downtown Los Angeles. He charges his customers an annual fee of $400 and has an existing customer base of 700. Paul plans to raise the annual fee by 6 percent every year and expects the club membership to grow at a consta
> What is the main difference between the WACC and APV methods?
> Burklin, Inc., has earnings of $21 million and is projected to grow at a constant rate of 5 percent forever because of the benefits gained from the learning curve. Currently, all earnings are paid out as dividends. The company plans to launch a new proje
> Hardwick Enterprises is evaluating alternative uses for a three-story manufacturing and warehousing building that it has purchased for $1,250,000. The company can continue to rent the building to the present occupants for $60,000 per year. The present oc
> The put–call parity condition is altered when dividends are paid. The dividend-adjusted put–call parity formula is: where d is again the continuously compounded dividend yield. a. What effect do you think the dividen
> Suppose you observe the following situation: Assume these securities are correctly priced. Based on the CAPM, what is the expected return on the market? What is the risk-free rate? Security Beta Expected Return Pete Corp. 1.35 12.28% Repete Co. .80
> How does a bond issuer decide on the appropriate coupon rate to set on its bonds? Explain the difference between the coupon rate and the required return on a bond.
> You are planning to save for retirement over the next 30 years. To save for retirement, you will invest $900 per month in a stock account in real dollars and $300 per month in a bond account in real dollars. The effective annual return of the stock accou
> The Stambaugh Corporation currently has earnings per share of $8.20. The company has no growth and pays out all earnings as dividends. It has a new project that will require an investment of $1.95 per share in one year. The project is only a two-year pro
> Suppose we are thinking about replacing an old computer with a new one. The old one cost us $450,000; the new one will cost $580,000. The new machine will be depreciated straight-line to zero over its five-year life. It will probably be worth about $130,
> In addition to the five factors discussed in the chapter, dividends also affect the price of an option. The Black–Scholes option pricing model with dividends is: All of the variables are the same as the Black–Scholes
> Consider the following information about Stocks I and II: The market risk premium is 7.5 percent, and the risk-free rate is 4 percent. Which stock has the most systematic risk? Which one has the most unsystematic risk? Which stock is “
> When Marilyn Monroe died, ex-husband Joe DiMaggio vowed to place fresh flowers on her grave every Sunday as long as he lived. The week after she died in 1962, a bunch of fresh flowers that the former baseball player thought appropriate for the star cost
> Why do we use an aftertax figure for cost of debt but not for cost of equity?
> This one’s a little harder. Suppose the current share price for the firm in the previous problem is $62.40 and all the dividend information remains the same. What required return must investors be demanding on Storico stock? (Hint: Set up the valuation f
> Your company has been approached to bid on a contract to sell 15,000 voice recognition (VR) computer keyboards a year for four years. Due to technological improvements, beyond that time they will be outdated and no sales will be possible. The equipment n
> Strudler Real Estate, Inc., a construction firm financed by both debt and equity, is undertaking a new project. If the project is successful, the value of the firm in one year will be $213 million, but if the project is a failure, the firm will be worth
> Assume a firm is considering a new typical project that requires an initial investment with sales, variable costs and fixed costs over its life. Will the project usually reach the accounting, cash, or financial break-even point first? Which will it reach
> Suppose the risk-free rate is 4.7 percent and the market portfolio has an expected return of 11.2 percent. The market portfolio has a variance of .0382. Portfolio Z has a correlation coefficient with the market of .28 and a variance of .3285. According t
> The following Treasury bond quote appeared in The Wall Street Journal on May 11, 2004: Why would anyone buy this Treasury bond with a negative yield to maturity? How is this possible?
