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Questions and Answers of Corporate Finance

Fabulous Fabricators needs to decide how to allocate space in its production facility this year. It is considering the following contracts:a. What are the profitability indexes of the projects?b.
Kartman Corporation is evaluating four real estate investments. Management plans to buy the properties today and sell them three years from today. The annual discount rate for these investments is
Orchid Biotech Company is evaluating several development projects for experimental drugs. Although the cash flows are difficult to forecast, the company has come up with the following estimates of
Daily Enterprises is purchasing a $10 million machine. It will cost $50,000 to transport and install the machine. The machine has a depreciable life of five years and will have no salvage value. If
The machine in Problem 1 will generate incremental revenues of $4 million per year along with incremental costs of $1.2 million per year. If Daily’s marginal tax rate is 35%, what are the
You are upgrading to better production equipment for your firm’s only product. The new equipment will allow you to make more of your product in the same amount of time. Thus, you forecast that
Pisa Pizza, a seller of frozen pizza, is considering introducing a healthier version of its pizza that will be low in cholesterol and contain no trans fats. The firm expects that sales of the new
Kokomochi is considering the launch of an advertising campaign for its latest dessert product, the Mini Mochi Munch. Kokomochi plans to spend $5 million on TV, radio, and print advertising this year
Hyperion, Inc., currently sells its latest high-speed color printer, the Hyper 500, for $350. It plans to lower the price to $300 next year. Its cost of goods sold for the Hyper 500 is $200 per unit,
You have a depreciation expense of $500,000 and a tax rate of 35%. What is your depreciation tax shield?
You have forecast pro-forma earnings of $1,000,000. This includes the effect of $200,000 in depreciation. You also forecast a decrease in working capital of $100,000 that year. What is your forecast
Your pro-forma income statement shows sales of $1,000,000, cost of goods sold as $500,000, depreciation expense of $100,000, and taxes of $160,000 due to a tax rate of 40%. What are your pro-forma
You are forecasting incremental free cash flows for Daily Enterprises. Based on the information in Problems 1 and 2, what are the incremental free cash flows associated with the new machine?
Castle View Games would like to invest in a division to develop software for video games. To evaluate this decision, the firm first attempts to project the working capital needs for this operation.
In the HomeNet example from the chapter, its receivables are 15% of sales and its payables are 15% of COGS. Forecast the required investment in net working capital for HomeNet assuming that sales and
Elmdale Enterprises is deciding whether to expand its production facilities. Although long-term cash flows are difficult to estimate, management has projected the following cash flows for the first
Cellular Access, Inc., is a cellular telephone service provider that reported net income of $250 million for the most recent fiscal year. The firm had depreciation expenses of $100 million, capital
Recall the HomeNet example from the chapter. Suppose HomeNet’s lab will be housed in warehouse space that the company could have otherwise rented out for $200,000 per year during years 1–4. How
One year ago, your company purchased a machine used in manufacturing for $110,000. You have learned that a new machine is available that offers many advantages; you can purchase it for $150,000
Beryl’s Iced Tea currently rents a bottling machine for $50,000 per year, including all maintenance expenses. It is considering purchasing a machine instead and is comparing two options:a. Purchase
You have just completed a $20,000 feasibility study for a new coffee shop in some retail space you own. You bought the space two years ago for $100,000, but if you sold it today, you would net
You purchased a machine for $1 million three years ago and have been applying straight-line depreciation to zero for a seven-year life. Your tax rate is 35%. If you sell the machine right now (after
The Jones Company has just completed the third year of a five-year MACRS recovery period for a piece of equipment it originally purchased for $300,000.a. What is the book value of the equipment?b. If
Just before it is about to sell the equipment from Problem 20, Jones receives a new order. It can take the new order if it keeps the old equipment. Is there a cost to taking the order and if so, what
Home Builder Supply, a retailer in the home improvement industry, currently operates seven retail outlets in Georgia and South Carolina. Management is contemplating building an eighth retail store
If Daily Enterprises uses MACRS instead of straight-line depreciation, which incremental free cash flows from Problem 10 would increase and which would decrease?
Markov Manufacturing recently spent $15 million to purchase some equipment used in the manufacture of disk drives. The firm expects that this equipment will have a useful life of five years, and its
You are a manager at Percolated Fiber, which is considering expanding its operations in synthetic fiber manufacturing. Your boss comes into your office, drops a consultant's report on your desk, and
Bauer Industries is an automobile manufacturer. Management is currently evaluating a proposal to build a plant that will manufacture lightweight trucks. Bauer plans to use a cost of capital of 12%
Billingham Packaging is considering expanding its production capacity by purchasing a new machine, the XC-750. The cost of the XC-750 is $2.75 million. Unfortunately, installing this machine will
Why is it that real options must have positive value?
What kind of real option does the XC-900 machine provide to Billingham in Problem 27?
If Billingham knows that it can sell the XC-750 to another firm for $2 million in two years, what kind of real option would that provide?
This year, FCF, Inc., has earnings before interest and taxes of $10 million, depreciation expenses of $1 million, capital expenditures of $1.5 million, and has increased its net working capital by
Victoria Enterprises expects earnings before interest and taxes (EBIT) next year of $1 million. Its depreciation and capital expenditures will both be $300,000, and it expects its capital
The present value of JECK Co.’s expected free cash flows is $100 million. If JECK has $30 million in debt, $6 million in cash, and 2 million shares outstanding, what is its share price?
Portage Bay Enterprises has $1 million in excess cash, no debt and is expected to have free cash flow of $10 million next year. Its FCF is then expected to grow at a rate of 3% per year forever. If
Heavy Metal Corporation is expected to generate the following free cash flows over the next five years:After then, the free cash flows are expected to grow at the industry average of 4% per year.
Covan, Inc., is expected to have the following free cash flows:a. Covan has 8 million shares outstanding, $3 million in excess cash, and it has no debt. If its cost of capital is 12%, what should
Sora Industries has 60 million outstanding shares, $120 million in debt, $40 million in cash, and the following projected free cash flow for the next four years (see MyFinanceLab for the data in
Consider the valuation of Nike given in Example 10.1.a. Suppose you believe Nike’s initial revenue growth rate will be between 7% and 11% (with growth always slowing linearly to 5% by year 2015).
You notice that Dell Computers has a stock price of $27.85 and EPS of $1.26. Its competitor Hewlett-Packard has EPS of $2.47. What is one estimate of the value of a share of Hewlett-Packard stock?
CSH has EBITDA of $5 million. You feel that an appropriate EV/EBITDA ratio for CSH is 9. CSH has $10 million in debt, $2 million in cash, and 800,000 shares outstanding. What is your estimate of
After researching the competitors of EJH Enterprises, you determine that most comparable firms have the following valuation ratios (see MyFinanceLab for the data in Excel format):EJH Enterprises has
Suppose that in May 2010, Nike had EPS of $3.51 and a book value of equity of $18.92 per share.a. Using the average P/E multiple in Table 10.1, estimate Nike's share price.b. What range of share
Suppose that in May 2010, Nike had sales of $19,176 million, EBITDA of $2,809 million, excess cash of $3,500 million, $437 million of debt, and 485.7 million shares outstanding.a. Using the average
Suppose Rocky Shoes and Boots has earnings per share of $2.30 and EBITDA of $30.7 million. The firm also has 5.4 million shares outstanding and debt of $125 million (net of cash). You believe Deckers
Summit Systems has an equity cost of capital of 11%, will pay a dividend of $1.50 in one year and its dividends had been expected to grow by 6% per year. You read in the paper that Summit has
Assume that Cola Company has a share price of $43. The firm will pay a dividend of $1.24 in one year, and you expect Cola Co. to raise this dividend by approximately 7% per year in perpetuity.a. If
Roybus, Inc., a manufacturer of flash memory, just reported that its main production facility in Taiwan was destroyed in a fire. Although the plant was fully insured, the loss of production will
Apnex, Inc., is a biotechnology firm that is about to announce the results of its clinical trials of a potential new cancer drug. If the trials were successful, Apnex stock will be worth $70 per
You have a $100,000 portfolio made up of 15 stocks. You trade each stock five times this year and each time you trade, you pay about $30 in commissions and spread. You have no special knowledge, so
Assume the annual return for the lowest turnover portfolio is 18% and the annual return for the highest turnover portfolio is 12%. If you invest $100,000 and have the highest turnover, how much lower
You bought a stock one year ago for $50 per share and sold it today for $55 per share. It paid a $1 per share dividend today. What was your realized return?
How much of the return in Problem 1 came from dividend yield and how much came from capital gain?
Repeat Problems 1 and 2 assuming instead that the stock fell $5 to $45.a. Is your capital gain different? Why or why not?b. Is your dividend yield different? Why or why not?
You have just purchased a share of stock for $20. The company is expected to pay a dividend of $0.50 per share in exactly one year. If you want to earn a 10% return on your investment, what price do
The following table contains prices and dividends for a stock. All prices are after the dividend has been paid. If you bought the stock on January 1 and sold it on December 31, what is your
Download the spreadsheet from the textbook's Web site containing the data for Figure.a. Compute the average return for each of the assets from 1929 to 1940 (the Great Depression).b. Compute the
Ten annual returns are listed in the following table.a. What is the arithmetic average return over the ten-year period?*b. What is the geometric average return over the ten-year period?c. If you
Using the data in the table below, calculate the return for investing in this stock from January 1 to December 31. Prices are after the dividend has been paid (see MyFinanceLab for the data in
What was your dividend yield from investing in the stock in Problem 8? What was your capital gain?
Consider the following five monthly returns:a. Calculate the arithmetic average monthly return over this period.*b. Calculate the geometric average monthly return over this period.c. Calculate the
Explain the difference between the arithmetic average return you calculated in Problem 10a and the geometric average return you calculated in Problem 10b. Are both numbers useful? If so, explain why.
The last four years of returns for a stock are as follows:a. What is the average annual return?b. What is the variance of the stock€™s returns?c. What is the standard deviation of the
Calculate the 95% prediction intervals for the four different investments included in Figures (1) and(2).
You are choosing between the four investments from Problem 13 and you want to be 95% certain that you do not lose more than 8% on your investment. Which investments should you choose?
If returns of S&P 500 stocks are normally distributed, what range of returns would you expect to see 95% of the time? Base your answer on Figures (1) and(2).
You observe a portfolio for five years and determine that its average return is 12% and the standard deviation of its returns is 20%. Can you be 95% confident that this portfolio will not lose more
Using the data in Critical Thinking Question 6, calculatea. The expected overall payoff of each bank.b. The standard deviation of the overall payoff of each bank.
You are a risk-averse investor who is considering investing in one of two economies. The expected return and volatility of all stocks in both economies is the same. In the first economy, all stocks
You buy 100 shares of Tidepool Co. for $40 each and 200 shares of Madfish, Inc., for $15 each. What are the weights in your portfolio?
Fremont Enterprises has an expected return of 15% and Laurelhurst News has an expected return of 20%. If you put 70% of your portfolio in Laurelhurst and 30% in Fremont, what is the expected return
You are considering how to invest part of your retirement savings. You have decided to put $200,000 into three stocks: 50% of the money in GoldFinger (currently $25/share), 25% of the money in
You have $70,000. You put 20% of your money in a stock with an expected return of 12%, $30,000 in a stock with an expected return of 15%, and the rest in a stock with an expected return of 20%.
There are two ways to calculate the expected return of a portfolio: either calculate the expected return using the value and dividend stream of the portfolio as a whole, or calculate the weighted
If the returns of two stocks have a correlation of 1, what does this imply about the relative movements in the stock prices?
Stocks A and B have the following returns (see MyFinanceLab for the data in Excel format):a. What are the expected returns of the two stocks?b. What are the standard deviations of the returns of the
Using the data in the following table, estimate the average return and volatility for each stock (see MyFinanceLab for the data in Excelformat).
Using your estimates from Problem 8 and the fact that the correlation of A and B is 0.48, calculate the volatility (standard deviation) of a portfolio that is 70% invested in stock A and 30% invested
The following spreadsheet contains monthly returns for Cola Co. and Gas Co. for 2010. Using these data, estimate the average monthly return and volatility for each stock (see MyFinanceLab for the
Using the spreadsheet from Problem 10 and the fact that Cola Co. and Gas Co. have a correlation of 0.6083, calculate the volatility (standard deviation) of a portfolio that is 55% invested in Cola
Suppose Johnson & Johnson and the Walgreen Company have the expected returns and volatilities shown below, with a correlation of 22%.For a portfolio that is equally invested in Johnson &
You have a portfolio with a standard deviation of 30% and an expected return of 18%. You are considering adding one of the two stocks in the table below. If after adding the stock you will have 20%
Your client has $100,000 invested in stock A. She would like to build a two-stock portfolio by investing another $100,000 in either stock B or C. She wants a portfolio with an expected return of at
Suppose all possible investment opportunities in the world are limited to the five stocks listed in the table below. What are the market portfolio weights
Given $100,000 to invest, construct a value-weighted portfolio of the four stocks listedbelow
If one stock in a value-weighted portfolio goes up in price and all other stock prices remain the same, what trades are necessary to keep the portfolio value weighted?
You hear on the news that the S&P 500 was down 2% today relative to the risk-free rate (the market’s excess return was –2%). You are thinking about your portfolio and your investments in Apple
Go to Chapter Resources on MyFinanceLab and use the data in the spreadsheet provided to estimate the beta of Nike stock using linear regression.
The Chapter Resources section of MyFinanceLab has data on Microsoft and the S&P 500 from 1986 to 2006.a. Estimate Microsoft’s beta using linear regression over the periods 1987–1991,
Suppose the risk-free return is 4% and the market portfolio has an expected return of 10% and a standard deviation of 16%. Johnson & Johnson Corporation stock has a beta of 0.32. What is its
What is the sign of the risk premium of a negative-beta stock? Explain. (Assume the risk premium of the market portfolio is positive.)
EJH has a beta of 1.2, CSH has a beta of 0.6, and KMS has a beta of 1.0. If you put 25% of your money in EJH, 25% in CSH, and 50% in KMS, what is the beta of your portfolio?
Suppose Intel stock has a beta of 1.6, whereas Boeing stock has a beta of 1. If the risk-free interest rate is 4% and the expected return of the market portfolio is 10%, according to the CAPM,a.
You are thinking of buying a stock priced at $100 per share. Assume that the riskfree rate is about 4.5% and the market risk premium is 6%. If you think the stock will rise to $117 per share by the
You are analyzing a stock that has a beta of 1.2. The risk-free rate is 5% and you estimate the market risk premium to be 6%. If you expect the stock to have a return of 11% over the next year,
You have risen through the ranks of a coffee company, from the lowly green-apron barista to the coveted black apron, and all the way to CFO. A quick Internet check shows you that your company’s
At the beginning of 2007, Apple’s beta was 1.4 and the risk-free rate was about 4.5%. Apple’s price was $84.84. Apple’s price at the end of 2007 was 198.08. If you estimate the market risk
You want to invest $50,000 in a portfolio with a beta of no more than 1.4 and an expected return of 12.4%. Bay Corp. has a beta of 1.2 and an expected return of 11.2%, and City Inc. has a beta of

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