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corporate finance

Questions and Answers of Corporate Finance

Portfolio Risk if a portfolio has a positive investment in every asset, can the standard deviation on the portfolio be less than that on every asset in the portfolio? What about the portfolio beta?
Beta and CAPM Is it possible that a risky asset could have a beta of zero? Explain. Based on the CAPM, what is the expected return on such an asset? Is it possible that a risky asset could have a
Corporate Downsizing In recent years, it has been common for companies to experience significant stock price changes in reaction to announcements of massive layoffs. Critics charge that such events
Earnings and Stock Returns As indicated by a number of examples in this chapter. Earnings announcements by companies are closely followed by, and frequently result in, share price revisions. Two
Determining Portfolio Weights What are the portfolio weights for a portfolio that has 100 shares of Stock A that sell for $40 per share and 130 shares of Stock B that sell for $22 per share?
Portfolio Expected Return you own a portfolio that has $2,300 invested in tock A and $3,400 invested in Stock B. If the expected returns on these stocks are 11 percent and 16 percent, respectively,
Portfolio Expected Return you own a portfolio that is 50 percent invested in Stock X. 30 percent in Stock Y, and 20 percent in Stock Z. The expected returns on these three stocks are 10 percent, 16
Portfolio Expected Return you have $10,000 to invest in a stock portfolio. Your choices are Stock X with an expected return of 15 percent and Stock Y with an expected return of 10 percent. If your
Calculating expected return based on the following information calculate the expected return
Calculating Expected Return Based on the following information, calculate the expected return:
Calculating Returns and Standard Deviations Based on the following information, calculate the expected return and standard deviation for the two stocks:
Calculating Expected Returns A portfolio is invested 10 percent in Stock, 75 percent in Stock 3, - and 15 percent in Stock K. The expected returns on these stocks are 8 percent, 15 percent, and 24
Returns and Standard Deviations 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
Returns and Standard Deviations 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.
Calculating Portfolio Betas You own a stock portfolio invested 25 percent in Stock Q, 20 percent in Stock R, 15 percent in Stock 5, and 40 percent in Stock T. The betas for these four stocks are .75,
Calculating Portfolio Betas you own a portfolio equally invested in a risk-free asset and two stocks. If one of the stocks has a beta of 1.65 and the total portfolio is equally as risky as the
Using CAPM A stock has a beta of 1.25 the expected return on the market is 14 percent, and the risk-free rate is 5.2 percent. What must the expected return on this stock be?
Using CAPM A stock has an expected return of 13 percent, the risk-free rate is 4.5 percent, and the market risk premium is 7 percent. What must the beta of this stock be?
Using CAPM A stock has an expected return of 10 percent, its beta is .70, and the risk-free rate is 5.5 percent. What must the expected return on the market be?
Using CAPM A stock has an expected return of 15 percent, its beta is 1.45, and the expected return on the market is 12 percent. What must the risk-free rate be?
Using CAPM A stock has a beta of 1.30 and an expected return of 17 percent. A risk-free asset currently earns 5 percent.a. What is the expected return on a portfolio that is equally invested in the
Using the SML Asset W has art expected return of 15 percent and a beta of 1.2, if the risk-free rate is 5 percent, complete the following table for portfolios of Asset W and a risk-free asset,
Reward-to-Risk Ratios Stock Y has a beta of 1.40 and an expected return of 19 percent. Stock Z has a beta of .65 and an expected return of 10.5 percent. If the risk-free rate is 6 percent and the
Reward-to-Risk Ratios In the previous problem, what would the risk-free rate have to be for the two stocks to be correctly priced?Stock Y has a beta of 1.40 and an expected return of 19 percent.
Portfolio Returns using information from the previous chapter on capital market history, determine the return on a portfolio that is equally invested in large-company stocks and long-term government
CAPM Using the CAPM, show that the ratio of the risk premiums on two assets is equal to the ratio of their betas.
Portfolio Returns and Deviations consider the following information about three stocks:a. If your portfolio is invested 40 percent each in A and B and 20 percent in C, what is the portfolio expected
Portfolio Returns and Deviations consider the following information about three stocks:a. If your portfolio is invested 40 percent each in A and B and 20 percent in C, what is the portfolio expected
Analyzing a Portfolio you have $100,000 to invest in a portfolio containing Stock X, Stock Y, and a risk-free asset. You must invest all of your money. Your goal is to create a portfolio that has an
Systematic versus Unsystematic Risk Consider the following information about Stocks I and II: The market risk premium is 8 percent, and the risk-free rate is 4 percent. Which stock has the most
SML 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?
SML 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
Options what is a call option a put option under what circumstances might you want to buy each? Which one has greater potential profit? Why?
Options complete the following sentence for each of these investors:a. A buyer of call options.b. A buyer of put options.c. A seller (writer) of call options.d. A seller (writer) of put options.
Intrinsic Value what is the intrinsic value of a call option? How do we interpret this value?
Put Options what is the value of a put option at maturity? Based on your answer, what is the intrinsic value of a put option?
Option Pricing you notice that shares of stock in the Patel Corporation are going for $50 per share. Call options with an exercise price of $35 per share are selling for $10. What’s wrong here?
Options and Stock Risk if the risk of a stock increases, what is likely to happen to the price of call options on the stock to the price of put options why?
Option Rise true or false: The unsystematic risk of a share of stock is irrelevant in valuing the stock because it can be diversified away; therefore, it is also irrelevant for valuing a call option
Option pricing 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, the put or
Option Price and Interest Rates suppose the interest rate on T-bills suddenly and unexpectedly rises. All other things being the same, what is the impact on call option values? On put option values?
Contingent Liabilities when you takeout an ordinary student loan, it is usually the case that whoever holds that loan is given a guarantee by the U.S. government, meaning that the government will
Option to abandon what is the option to abandon? Explain why we underestimate NPV if we ignore this option.
Option to expand what is the option to expand? Explain why we underestimate NPV if we ignore this option.
Capital Budgeting Options in Chapter 10, we discussed Porsche’s launch of its new Cayenne. Suppose sales of the Cayenne go extremely well and Porsche is forced to expand output to meet demand.
Option to suspend natural resource extraction facilities (such as oil wells or gold mines) provides a good example of the value of the option to suspend operations. Why?
Employee Stock Options you own stock in the Hendrix Guitar Company. The company has implemented a plan to award employee stock options. As a shareholder, does the plan benefit you? If so, what are
Calculating Option Values T-bills currently yield 6.2 percent. Stock in Pinta Manufacturing is currently selling for $55 per share. There is no possibility that the stock will be worth less than $50
Understanding Option Quotes Use the option quote information shown here to answer the questions that follow. The stock is currently selling for $94. a. Are the call options in the money? What is the
Calculating Payoffs 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
Calculating Option Values The price of Time Squared Corp. stock will be either $77 or $93 at the end of the year. Call options are available with one year to expiration. T-bills currently yield 6
Calculating option values the price of dimension, Inc., stock will be either $65 or $85 at the end of the year. Call options are available with one year to expiration. T-bills currently yield 5
Using the pricing equation a one-year call option contract on Cheesy Poofs Co. stock sells for $1.200. In one year, the stock will be worth $45 or $65 per share. The exercise price on the call option
Equity as an Option Rackin Pinion Corporation’s assets are currently worth $1,040. In one year, they will be worth either $1,000 or $1,350. The risk-free interest rate is 6 percent. Suppose Rackin
Equity as an option Buckeye industries has a bond issue with a face value of $1,000 that is coming due in one year. The value of Buckeye’s assets is currently $1,200. Jim Tressell, the CEO,
Calculating conversion value a $1,000 par convertible debenture has a conversion price for common stock of $40 per share. With the common stock selling at $55, what is the conversion value of the
Convertible Bonds The following facts apply to a convertible bond making semiannual payments: a. What is the minimum price at which the convertible should sell? b. What accounts for the premium of
Calculating Values for Convertibles You have been hired to value a new 30-year callable, convertible bond. The bond has a 7 percent coupon, payable annually, and its face value is $1,000. The
Calculating Warrant Values A bond with 20 detachable warrants has just been offered for sale at $1,000. The bond matures in 15 years and has an annual coupon of $105. Each warrant gives the owner the
Option to Walt Your Company is deciding whether to invest in a new machine. The new machine will increase cash flow by $350,000 per year. You believe the technology used in the machine has a 10-year
Abandonment Value We are examining a new project. We expect to sell 7,000 units per year at $65 net cash flow apiece for the next 10 years. In other words, the annual operating cash flow is projected
Abandonment in the previous problem, suppose you think it is likely that expected sales will be revised upward to 9.000 units if the first year is a success and revised downward to 4.000 units if the
Abandonment and Expansion in the previous problem, suppose the scale of the project can be doubled in one year in the sense that twice as many units can he produced and sold. Naturally, expansion
Intuition and Option Value suppose a share of stock sells for $75. The risk-free rate is 5 percent, and the stock price in one year will be either $85 or S95.a. What is the value of a call option
Intuition and Convertibles which of the following two sets of relationships at time of issuance of convertible bonds is more typical, why
Convertible Calculations Rayne Inc., has a $ 1.000 face value convertible bond issue that is currently selling in the market for $950. Each bond is exchangeable at any time for 25 shares of the
Abandonment Decisions Allied Products, Inc., is considering a new product launch. The firm expects to have annual operating cash flow of $25 million for the next 10 years. Allied Products uses a
Pricing Convertibles you have been hired to value a new 25-year callable, convertible bond. The bond has a 7.20 percent coupon, payable annually. The conversion price is $1.60, and the stock
WACC on the most basic level, if a firm’s WACC is 12 percent, what does this mean?
Book Values versus Market Values in calculating the WACC, if you had to use book values for either debt or equity, which would you choose? Why?
Project Risk 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?
WACC and Taxes why do we use an after tax figure for cost of debt but not for cost of equity?
DCF cost of Equity Estimation what are the advantages of using the DCF model for determining the cost of equity capital? What are the disadvantages? What specific piece of information do you need
SML cost of equity estimation what are the advantages of using the SML approach to finding the cost of equity capital? What are the disadvantages? What specific pieces of information are needed
Cost of Debt estimation 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?
Cost of capital suppose Tom O’Bedlam president of Bedlam Products, Inc., has hired you to determine the firm’s cost of debt and cost of equity capital.(a) The stock currently sells for $50
Company Risk versus Project Risk both Dow chemical Company, a large natural gas user, and Superior Oil, a major natural gas producer, are thinking of investing in natural gas wells near Houston. Both
Divisional Cost of Capital under what circumstances would it is appropriate for a firm to use different costs of capital for its different operating division? If the overall firm WACC were used as
The Mays Co just issued a dividend of $2.60 per share on its common stock. The company is expected to maintain a constant 6 percent growth rate in its dividends indefinitely. If the stock sells for
The city street corporation’s common stock has a beta 1.2. If the risk-free rate is 4.5 percent and the expected return on the market is 13 percent, what is the company’s cost of equity
Calculating cost of equity stock in country road industries has a beta of 1.25. The market risk premium is 7 percent, and T-bills are currently yielding 5 percent. Country Road’s most recent
Estimate the DCF Growth Rate suppose in a snap Ltd, just issued a dividend of $1.25 per share on its common stock. The company paid dividends of $.85, $.90, $1.04, and $1.10 per share in the last
Calculating cost of preferred stock Holdup Bank has an issue of preferred stock with a $5 stated dividend that just sold for $87 per share. What is the bank’s cost of preferred stock?
Calculating cost of debt Decline, Inc., is trying to determine its cost of debt. The firm has a debt issue outstanding with 12 years to maturity that is quoted at 94 percent of face value. The
Calculating cost of debt Jiminy’s Cricket Farm issued a 30-year, 9 percent semiannual bond 7 years ago. The bond currently sells for 108 percent of its face value. The company’s tax rate is 35
Calculating cost of debt for the firm in problem 7, suppose the book value of the debt issue is $70 million. In addition, the company has a second debt issue on the market, a zero coupon bond with
Calculating WACC Mullineaux Corporation has a target capital structure of 50 percent common stock, 5 percent preferred stock, and 45 percent debt. Its cost of equity is 15 percent, the cost of
Taxes an WACC Cookie Dough Manufacturing has a target debt-equity ratio of .80. Its cost of equity is 17 percent, and its cost of debt is 10 percent. If the tax rate is 35 percent, what is the
Finding the Target Capital Structure Fama’s LIamas has a weighted average cost of capital of 10.2 percent. The company’s cost of equity is 14 percent, and its pretax cost of debt is 8.4
Value of a Right show that the value of a right just prior to expiration can be written as: Value of right = PRO – Px = (PRO – PS) / (N + 1) where PRO, PS and Px stand for the rights-on-price,
Selling Rights Atlas Corp wants to raise $4.1 million via a rights offering. The company currently has 490,000 shares of common stock outstanding that sell for share. Its underwriter has set a
Valuing a right Knight inventory Systems, Inc., has announced a rights offer. The company has announced that it will take four rights to buy a new share in the offering at a subscription price of
Finding the WACC given the following information for Bellevue Power Co, find the WACC. Assume the company’s tax rate is 35 percent.Deb:5,000 7 percent coupon bonds outstanding, $1,000 par value, 20
Finding the WACC Titan Mining Corporation has 8.5 million shares of common stock outstanding, 200,000 shares of 7 percent preferred stock outstanding and 85,000 8.5 percent semiannual bonds
SML and WACC an all equity firm is considering the following projects:The T-bill rate is 5 percent, and the expected return on the market is 12 percent.a. Which projects have a higher expected return
Suppose your company needs $15 million to build a new assembly line. Your target debt-equity ratio is 90. The flotation cost for new equity is 8 percent, but the flotation cost for debt is only 5
Calculating Flotation Costs Southern Alliance Company needs to raise $30 million to start a new project and will raise the money by selling new bonds. The company has a target capital structure of
WACC and NPV stranger Inc., is considering a project that will result in initial after tax cash savings of $3.5 million at the end of the first year, and these savings will grow at a rate of 3
Flotation cost Goodbye, Inc., recently issued new securities to finance a new TV show. The project cost $10.5 million, and the company paid $750,000 in flotation costs. In addition, the equity issued
Calculating the cost of Debt Ying Import has several bond issues outstanding, each making semiannual interest payments. The bonds are listed in the following table. If the corporate tax rate is 34

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