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Questions and Answers of Corporate Finance

Much has been made about the sweeping changes that are occurring in Europe as a result of the euro. Will the euro help European firms become more efficient? Will it change the way multinational
Define ach of the following terms:a. Multinational corporationb. Exchange rate: fixed exchange rate system: floating exchange ratesc. Trade deficit: devaluation: revaluationd. Exchange rate risk;
Under the fixed exchange rate system, what was the currency against which all other currency values were defined? Why?
If the Swiss franc depreciates against the U.S. dollars can a dollar buy more or fewer Swiss francs as a result?
What is a Eurodollar? It a French citizen deposits $10,000 in Chase Bank in New York, have Eurodollars been created? What if the deposit is made in Barclays Bank in London? Chase’s Paris branch?
A currency trader observes that in the spot exchange market, 1 U.S. dollar can be exchanged for 9 Mexican pesos or for 111.23. Japanese yen. What is the cross rate between the yen and the peso; that
Foreign Investment Analysis 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
What is a multinational corporation? Why do firms expand into other countries? Citrus Products Inc. is a medium-sized producer of citrus juice drinks with groves in Indian River County, Florida.
What are the six major factors that distinguish multinational financial management from financial management as practiced by a purely domestic firm? Citrus Products Inc. is a medium-sized producer of
Consider the following illustrative exchange rates.U.S Dollars Required to Buy1 Unit of Foreign CurrencyEURO..........1.2500Swedish krona......0.1481(1) Are these currency prices direct quotations or
Briefly describe the current international monetary system. How does the current system differ from the system that was in place prior to August 1971? Citrus Products Inc. is a medium-sized producer
What is a convertible currency? What problems arise when a multinational company operates in a country whose currency is not convertible? Citrus Products Inc. is a medium-sized producer of citrus
What is the difference between spot rates and forward rates? When is the forward rate at a premium to the spot rate? At a discount? Citrus Products Inc. is a medium-sized producer of citrus juice
What is interest rate parity? Currently, you can exchange 1 euro for 1.2700 dollars in the 180-day forward marker, and the risk-free rate on 180-day securities is 6% in the United States and 4% in
What is purchasing power parity? If grapefruit Juice costs $2.00 a liter in the United States and purchasing power parity holds, what should be the price of grapefruit juice in Spain? Citrus Products
What effect does relative inflation have on interest rates and exchange rates? Citrus Products Inc. is a medium-sized producer of citrus juice drinks with groves in Indian River County, Florida.
Briefly discuss the international capital markets. Citrus Products Inc. is a medium-sized producer of citrus juice drinks with groves in Indian River County, Florida. Until now, the company has
To what extent do average capital structures vary across different countries? Citrus Products Inc. is a medium-sized producer of citrus juice drinks with groves in Indian River County, Florida. Until
Briefly describe special problems that occur in multinational capital budgeting, and describe the process for evaluating a foreign project. Now consider the following project: A U.S. company has the
Briefly discuss special factors associated with the following areas of multinational working capital management:(I) Cash management(2) Credit management(3) Inventory managementCitrus Products Inc. is
Describe the six primary capital budgeting decision criteria. What are their pros and cons, and how are they related to n maximizing shareholder wealth? Should managers use just one criterion, or
Why do conflicts sometimes arise between the net present value (NPV) and internal rate of return (IRR) methods; that is, what conditions can lead to conflicts? Can similar conflicts arise between
If management’s goal is to maximize shareholder wealth, should it focus on the regular IRR or the MIRR? Explain your answer.
Under what conditions might you find more than one IRR for a project? How would you decide whether or not to accept the project? If you were comparing two mutually exclusive projects, one with a
What is the unequal life problem, under what conditions is it relevant, and how should it be dealt with?
Whit is a post-audit, and whit is the purpose of this audit?
What is capital rationing, what conditions lead to it, and how should it be dealt with?
What types of projects require more detailed analysis in the capital budgeting process?
In what sense is a reinvestment rate assumption embodied in the NPV, IRR, and MIRR methods? What is the assumed reinvestment rate of each method? Discuss.
IRR Refer to Problem 12-1. What is the project’s IRR?Data from problem 12-1Project K has a cost of $52,125, its expected net cash inflows are $12,000 per year for 8 years, and its cost of capital
Payback Refer to Problem 12-1. What is the project’s payback period?Data from Problem 12-1Project K has a cost of $52,125, its expected net cash inflows are $12,000 per year for 8 years, and its
Discounted Payback Refer to Problem 12-1. What is the project’s discounted payback period?
Unequal Lives Filkins Fabric Company is considering the replacement of its old, fully depreciated knitting machine. Two new models are available: Machine 190-3, which has a cost of $190,000, a 3-year
You have just graduated from the MBA program of a large university, and one of your favorite courses was €œToday€™s Entrepreneurs.€ In fact, you enjoyed it so much you
What is the difference between independent and mutually exclusive projects?You have just graduated from the MBA program of a large university, and one of your favorite courses was "Today's
(1) Define the term net present value (NPV). What is each franchise's NPV?(2) What is the rationale behind the NPV method? According to NPV, which franchise or franchises should be accepted if they
(1) Define the term internal rate of return (IRR). What is each franchise's IRR?(2) How is the IRR on a project related to the YTM on a bond?(3) What is the logic behind the IRR method? According
(1) Draw NPV profiles for Franchises L and S. At what discount rate do the profiles cross?(2) Look at your NPV profile graph without referring to the actual NPVs and IRRs. Which franchise or
(1) What is the underlying cause o ranking conflicts between NPV and IRR?(2) What is the "reinvestment rate assumption," and how does it affect the NPV versus IRR conflict?(3) Which method is the
You have just graduated from the MBA program of a large university, and one of your favorite courses was "Today's Entrepreneurs." In fact, you enjoyed it so much you have decided you want to "be your
As a separate project (Project P), you are considering sponsoring a pavilion at the upcoming World's Fair. The pavilion would cost $800,000, and it is expected to result in $5 million of incremental
You have just graduated from the MBA program of a large university, and one of your favorite courses was €œToday€™s Entrepreneurs.€ In fact, you enjoyed it so much you
(1) What is the payback period? Find the paybacks for Franchises L and S.(2) What is the rationale for the payback method? According to the payback criterion, which franchise or franchises should be
In an unrelated analysis, you have the opportunity to choose between the following two mutually exclusive projects:The projects provide a necessary service, so whichever one is selected is expected
You are also considering another project that has a physical life of 3 years; that is, the machinery will be totally worn out after 3 years. However, if the project were terminated prior to the end
1. After examining all the potential projects, you discover that there are many more projects this year with positive NPVs than in a normal year. What two problems might this extra large capital
How do project cash flows as calculated in this chapter affect a firm’s corporate free cash flows as defined in Chapter 7 and then used in Chapter 11 to calculate a firm’s value? How does a
Define(a) Externalities and(b) Sunk costs, and then give examples of each that might be involved in a proposal by an energy company to build a new coal-fired electric power generating unit. How would
If Congress shortened depreciation lives for tax purposes, how would this affect the energy project’s NPV, assuming nothing else changes?
If the company’s capital budgeting analyst decided to show all projected cash flows, both positive and negative, in current dollars rather than inflation-adjusted dollars, would this affect the
Discuss some ways the company could estimate the project’s risk and then explain how risk might be incorporated into the decision analysis.
What are real options, and why are they important to capital budgeting?
Risky Cash Flows The Bartram-Pulley Company (BPC) must decide between two mutually exclusive investment projects. Each project costs $6,750 and has an expected life of 3 years. Annual net cash flows
Define “incremental cash flow.”(1) Should you subtract interest expense or dividends when calculating project cash flow?(2) Suppose the firm had spent $100,000 last year to rehabilitate the
Shrieves Casting Company is considering adding a new line to its product mix, and the capital budgeting analysis is being conducted by Sidney Johnson, a recently graduated MBA. The production line
Calculate the annual sales revenues and costs (other than depreciation). Why is it important to include inflation when estimating cash flows?Shrieves Casting Company is considering adding a new line
Construct annual incremental operating cash flow statements.Shrieves Casting Company is considering adding a new line to its product mix, and the capital budgeting analysis is being conducted by
Estimate the required net operating working capital for each year and the cash flow due to investments in net operating working capital.Shrieves Casting Company is considering adding a new line to
Calculate the after-tax salvage cash flow.Shrieves Casting Company is considering adding a new line to its product mix, and the capital budgeting analysis is being conducted by Sidney Johnson, a
Calculate the net cash flows for each year. Based on these cash flows, what are the project’s NPV, IRR, MIRR, PI, payback, and discounted payback? Do these indicators suggest the project should be
What does the term “risk mean in the context of capital budgeting; to what extent can risk be quantified; and when risk is quantified, is the quantification based primarily on statistical analysis
(1) What three types of risk are relevant in capital budgeting?(2) How is each of these risk types measured, and how do they relate to one another?(3) How is each type of risk used in the capital
(1) What is sensitivity analysis?(2) Perform a sensitivity analysis on the unit sales, salvage value, and cost of capital for the project. Assume each of these variables can vary from its
Assume that Sidney Johnson is confident of her estimates of all the variables that affect the project’s cash flows except unit sales and sales price. If product acceptance is poor, unit sales would
Are there problems with scenario analysis? Define simulation analysis, and discuss its principal advantages and disadvantages.Shrieves Casting Company is considering adding a new line to its product
(1) Assume Shrieves’ average project has a coefficient of variation in the range of 0.2 to 0.4. Would the new line be classified as high risk, average risk, or low risk? What type of risk is being
What is a real option? What are some types of real options?Shrieves Casting Company is considering adding a new line to its product mix, and the capital budgeting analysis is being conducted by
What’s the difference between a financial option and a real option? What are some specific types of real options? Do real options just occur, or can they be “created”?
Real options can be analyzed using a scenario approach with decision trees or using the Black-Scholes Option Pricing Model. What are the pros and cons of the two approaches? Is one procedure
Option values are extinguished when they are exercised. How does this influence capital budgeting decisions? What considerations, or types of analysis, might lead management to “take the plunge”
Suppose a company uses the NPV method, along with risk-adjusted WACCs, to calculate project NPVs. However, it has not been considering real options in its capital budgeting decisions. Now suppose
Good managers not only identify and evaluate real options in projects-they also structure projects so as to create real options. Suppose a company is considering a project to build an electric
In general, do timing options make it more or less likely that a project will be accepted today?
If a company has an option to abandon a project, would this tend to make the company more or less likely to accept the project today?
What are some types of real options?Assume you have just been hired as a financial analyst by Tropical Sweets Inc., a mid-sized California company that specializes in creating exotic candies from
What are five possible procedures for analyzing a real option?Assume you have just been hired as a financial analyst by Tropical Sweets Inc., a mid-sized California company that specializes in
Tropical Sweets is considering a project that will cost $70 million and will generate expected cash flows of $30 million per year for 3 years. The cost of capital for this type of project is 10%,
Now suppose this project has an investment timing option, since it can be delayed for a year. The cost will still be $70 million at the end of the year, and the cash flows for the scenarios will
Use decision tree analysis to calculate the NPV of the project with the investment timing option.Assume you have just been hired as a financial analyst by Tropical Sweets Inc., a mid-sized California
Use a financial option pricing model to estimate the value of the investment timing option.Assume you have just been hired as a financial analyst by Tropical Sweets Inc., a mid-sized California
Now suppose the cost of the project is $75 million and the project cannot be delayed. But if Tropical Sweets implements the project, then Tropical Sweets will have a growth option. It will have the
Tropical Sweets will replicate the original project only if demand is high. Using decision tree analysis, estimate the value of the project with the growth option.Assume you have just been hired as a
Use a financial option model to estimate the value of the project with the growth option.Assume you have just been hired as a financial analyst by Tropical Sweets Inc., a mid-sized California company
What happens to the value of the growth option if the variance of the project’s return is 14.2%? What if it is 50%? How might this explain the high valuations of many dot-com companies?Assume you
What is business risk? List and then discuss some factors that affect business risk.
What is financial risk? How is it related to business risk?
Who are Modigliani and Miller (MM), and what were their conclusions regarding the effect of capital structure on a firm’s value and cost of capital under the assumption of no corporate taxes?
Does the MM theory appear to be correct according to either empirical research or observations of firms’ actual behavior? How do assumptions affect your conclusion about whether MM appears to be
What is the trade-off-theory of capital structure? How does it differ from MM’s theory?
In general, does the market view the announcement of a new stock issue to be a good signal? Does the signaling theory lead to the same conclusions regarding the optimal capital structure as the
What does it mean to be at the optimal capital structure? What is optimized? What is maximized and what is minimized?
Should firms focus on book value or market value capital structures? How would the calculated WACC be affected by the use of book weights rather than market weights?
What would you expect to happen to an all-equity firm’s stock price if its management announced a recapitalization under which debt would be issued and used to repurchase common stock?
Firms with relatively high nonfinancial fixed costs are said to have a high degree of what?
“One type of leverage affects both EBIT and EPS. The other type affects only EPS.” Explain this statement.
Break-Even Quantity Shapland Inc. has fixed operating costs of $500,000 and variable costs of $50 per unit. If it sells the product for $75 per unit, what is the breakeven quantity?
Unlevered Beta Counts Accounting has a beta of 1.15. The tax rate is 40%, and Counts is financed with 20% debt. What is Counts’ unlevered beta?
Premium for Financial Risk Ethier Enterprise has an unlevered beta of 1.0. Ethier is financed with 50% debt and has a levered beta of 1.6. If the risk-free rate is 5.5% and the marker risk premium is
Value of Equity after Recapitalization Nichols Corporation’s value of operations is equal to $500 million after a recapitalization (the firm had no debt before the recap). It raised $200 million in
Break-Even Point Schweser Satellites Inc. produces satellite earth stations that sell for $100,000 each. The firm’s fixed costs, F, are $2 million, 50 earth stations are produced and sold each

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