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corporate finance

Questions and Answers of Corporate Finance

Treasury Bonds 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?
Real Cash Flows 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
Real Cash Flows you are planning to save for retirement over the next 30 years. To save for retirement, you will invest $700 a month in a stock account in real dollars and $300 a month in a bond
Stock Valuation why does the value of a share of stock depend on dividends?
Stock Valuation a substantial percentage of the companies listed on the NYSE and NASDAQ don’t pay dividends, but investors are nonetheless willing to buy shares in them. How is this possible given
Dividend Policy referring to the previous questions, under what circumstances might a company chooses not to pay dividends?
Dividend Growth Model Under what two assumptions can we use the dividend growth model presented in the chapter to determine the value of a share of stock? Comment on the reasonableness of these
Common versus Preferred Stock Suppose a company has a preferred stock issue and a common stock issue. Both have just paid a $2 dividend. Which do you think will have a higher price, a share of the
Dividend Growth Model Based on the dividend growth model, what are the two components of the total return on a share of stock? Which do you think is typically larger?
Growth Rate 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?
Voting Rights When it comes to voting in elections, what are the differences between US political democracy and U.S. corporate democracy?
Corporate Ethics is it unfair or unethical for corporations to create classes of stock with unequal voting rights?
Voting Rights some companies, such as Reader’s Digest have created classes of stock with no voting rights at all why would investors buy such stock?
Voting Rights some companies, such as Reader’s Digest have created classes of stock with no voting rights at all why would investors buy such stock?
Two-Stage Dividend Growth Model one of the assumptions of the two-stage growth model is that the dividends drop immediately from the high growth rate to the perpetual growth rate. What do you think
Stock Values the Jackson—Timberlake Wardrobe Co. just paid a dividend of $1.60 per share on its stock. The dividends are expected to grow at a constant rate of 6 percent per year indefinitely. If
Stock Values the next dividend payment by Top Knot, Inc., will be $2.50 per share. The dividends are anticipated to maintain a 5percent growth rate forever. If the stuck currently sells for $48.00
Stock Values For the company in the previous problem, what is the dividend yield? What is the expected capital gains yield?
Stock Values Stairway Corporation will pay a $3.60 per share dividend next year. The company pledges to increase its dividend by 4.5 percent per year indefinitely. If you require an 11 percent return
Stock Valuation Listen Close Co. is expected to maintain a constant 6.5 percent growth rate in its dividends indefinitely. If the company has a dividend yield of 3.6 percent, what is the required
Stock Valuation Suppose you know that a company’s stock currently sells for $60 per share and the required return on the stock is 12 percent. You also know that the total return on the stock is
Stock Valuation No More Corp. pays a constant $11 dividend on its stock. The company will maintain this dividend for the next eight years and will then cease paying dividends forever. If the required
Valuing Preferred Stock Ayden, Inc., has an issue of preferred stock outstanding that pays a $6.50 dividend every year in perpetuity If this issue currently sells for SI 13 per share, what is the
Stock Valuation Great Pumpkin Farms just paid a dividend of $3.50 on its stock. The growth rate in dividends is expected to be a constant 5 percent per year indefinitely. Investors require a 16
Non constant Growth Metallica Bearings. Inc., is a young start-up company. No dividends be paid on the stock over the next nine years because the firm needs to plow back its earnings to fuel growth.
Non constant Dividends Spears, Inc., has an odd dividend policy. The company has just paid a dividend of Si per share and has announced that it will increase the dividend by $4 per share for each of
Non constant Dividends North Side Corporation is expected to pay the following dividends over the next four years: $8, $7, $5, and $2. Afterward, the company pledges to maintain a constant 5 percent
Supernormal Growth Rizzi Co. is growing quickly. Dividends are expected to grow at a 25 percent rate for the next three years, with the growth rate falling off to a constant 7 percent thereafter. If
Supernormal Growth Janicek Corp. is experiencing rapid growth. Dividends are expected to grow at 25 percent per year during the next three years, 15 percent over the following year, and then 8
Negative Growth Antiques R Us is a mature manufacturing firm. The company just paid a $10 dividend, but management expects to reduce the payout by 6 percent per year indefinitely. If you require an
Finding the Dividend Ames Corporation stock currently sells for $50 per share. The market requires a 13 percent return on the firm’s stock. If the company maintains a constant 5 percent growth rate
Valuing Preferred Stock Best Rate Bank just issued some new preferred stock. The issue will pay a $10 annual dividend in perpetuity, beginning 10 years from now. If the market requires a 7 percent
Using Stock Quotes You have found the following stock quote for RJW Enterprises, Inc., in the financial pages of today??s newspaper. What was the closing price for this stock that appeared in
Two-Stage Dividend Growth Model Formula 51 Corp. just paid a dividend of $1.45 per share. The dividends are expected to grow at 30 percent for the next eight years and then level off to a 7 percent
Two-Stage Dividend Growth Model Chartreuse County Choppers Inc. i experiencing rapid growth, the company expect dividends to grow at 25 percent per year for the next nine years before leveling off at
Capital Gains versus Income Consider four different stocks, all of which have a required return of 18 percent and a most recent dividend of $4.50 per share. Stocks W, X, and Y are expected to
Stock Valuation most corporations pay quarterly dividends on their common stock rather than annual dividends. Barring any unusual circumstances during the year, the board raises, lowers, or maintains
Non constant Growth Storico Co. just paid a dividend of $2.75 per share. The company will increase its dividend by 20 percent next year and will then reduce its dividen4 growth rate by 5 percentage
Non constant Growth this one’s a little harder. Suppose the current share price for the firm in the previous problem is S60.98 and all the dividend information remains the same. What required
Constant Dividend Growth Model Assume a stock has dividends that grow at a constant rate forever. If you value the stock using the constant dividend growth model, how many years worth of dividends
Two-Stage Dividend Growth Regarding the two-stage dividend growth model in the chapter, show that the price of a share of stock today can be written as follows: Can you provide an intuitive
Two-Stage Dividend Growth the chapter shows that in the two-stage dividend growth model, the growth rate in the first stage, g1, can be greater than or less than the discount rate, R. Can they be
Payback Period and Net Present Value If a project with conventional cash flows has a payback period less than the project’s life, can you definitively state the algebraic sign of the NPV? Why or
Net Present Value Suppose a project has conventional cash flows and a positive we NPV. What do you know about its payback, its discounted payback, its profitability index, its IRR? Explain.
Payback Period concerning payback:a. Describe how the payback period is calculated, and describe the information this measure provides about a sequence of cash flows. What is the payback criterion
Discounted Payback Concerning discounted payback:a. Describe how the discounted payback period is calculated, and describe the information this measure provides about a sequence of cash flows. What
Average Accounting Return Concerning AAR:a. Describe how the average accounting return is usually calculated, and describe the information this measure provides about a sequence of cash flows. What
Net Present Value Concerning NPV:a. Describe how NPV is calculated, and describe the information this measure provides about a sequence of cash flows. What is the NPV criterion decision rule?b. Why
Internal Rate of Return Concerning IRR:a. Describe how the IRR is calculated, and describe the information this measure provides about a sequence of cash flows. What is the IRR criterion decision
Profitability Index Concerning the profitability index:a, Describe how the profitability index is calculated, and describe the information this measure provides about a sequence of cash flows. What
Payback and Internal Rate of Return A project has perpetual cash flows of C per period, a cost of I, and a required return of R. What is the relationship between the project’s payback and its
International Investment Projects In November 2004, automobile manufacturer Honda announced plans to build an automatic transmission plant in Georgia and expand its transmission plant in Ohio. Honda
Capital Budgeting Problems What difficulties might come up in actual applications of the various criteria we discussed in this chapter? Which one would be the easiest to implement in actual
Capital Budgeting in Not-for-Profit Entities Are the capital budgeting criteria we discussed applicable to not-for-profit corporations? How should such entities make capital budgeting decisions?
Modified Internal Rate of Return One of the less flattering interpretations of the acronym MIRR is “meaningless internal rate of return.” Why do you think this term is applied to MIRR?
Net Present Value It is sometimes stated that “the Net Present Value approach assumes reinvestment of the intermediate cash flows at the required return.” Is this claim correct? To answer,
Internal Rate of Return It is sometimes stated that “the internal rate of return approach assumes reinvestment of the intermediate cash flows at the internal rate of return.” Is this claim
Calculating Payback what is the payback period for the following set of cash flows?
Calculating Payback An investment project provides cash inflows of $860 per year for eight years. What is the project payback period if the initial cost is $3,000? What if the initial cost is
Calculating Payback Old Country, Inc., imposes a payback cutoff of three years for its international investment projects. If the company has the following two projects available, should it accept
Calculating Discounted Payback An investment project has annual cash inflows of $6,500, $7,000, $7,500, and $8,000, and a discount rate of 14 percent. What is the discounted payback period for
Calculating Discounted Payback An investment project costs $15,000 and has annual cash flows of $3,700 for six years. What is the discounted payback period if the discount rate is zero percent what
Calculating AAR you’re trying to determine whether to expand your business by building a new manufacturing plant. The plant has an installation cost of $18 million, which will be depreciated
Calculating IRR A firm evaluates all of its projects by applying the IRR rule. If the required return is 18 percent, should the firm accept the following project?
Calculating NPV for the cash flows in the previous problem, suppose the firm uses the NPV decision rule. At a required return of 11 percent, should the firm accept this project? What if the required
Calculating NPV and IRR a project that provides annual cash flows of $24,000 for nine years costs $110,000 today is this a good project if the required return is 8 percent? What if it’s 20 per-
Calculating IRR what is the IRR of the following set of cash flows?
Calculating NPV for the cash flows in the previous problem, what is the NPV at a discount rate of zero percent? What if the discount rate is 10 percent if it is 20 percent if it is 30 percent?
NPV versus IRR Bumble??s Bees, Inc., has identified the following two mutually exclusive projects: a. What is the 1RR for each of these projects? Using the IRR decision rule, which project should the
NPV versus IRR Consider the following two mutually exclusive projects: Sketch the NPV profiles for X and Y over a range of discount rates from zero to 25 percent. What is the crossover rate for these
Problems with IRR Sweet Petroleum, Inc., is trying to evaluate a generation project with the following cash flows: a. If the company requires a 10 percent return on its investments, should it accept
Calculating Profitability, index what is the profitability index for the following set of cash flows if the relevant discount rate is 10, percent what if the discount rate is 15 percent, if it is
Problems with Profitability Index The Shine On Computer Corporation are trying to choose between the following two niutia1ly exclusive design projects: a. If the required return is 10 percent and the
Comparing Investment Criteria Consider the following two mutually exclusive projects: Whichever project you choose, if any, you require a 15 percent return on your investment. a. If you apply the
NPV and Discount Rates An investment has an installed cost of $724,860. The cash flows over the four-year life of the investment are projected to be $324,186, $375,085, $354,302, and $205,680. If the
MIRR Slow Ride Corp is evaluating a project with the following cash flows: The Company uses a 10 percent interest rate on all of its projects. Calculate the MIRR of the project using all three
NPV and the Profitability Index If we define the NPV index as the ratio of NPV to cost, what is the relationship between this index and the profitability index?
Cash Flow Intuition A project has an initial cost of 1, has required return of R, and pays C annually for N years.a. Find C in terms of l and N such that the project has a payback period just equal
MIRR Suppose the company in Problem 19 uses an 11 percent discount rate and an 8 percent reinvestment rate on all of its projects. Calculate the MIRR of the project using all three methods using
Payback and NPV An investment under consideration has a payback of seven years and a cost of 5537.000. If the required return is 12 percent, what is the worst-case NPV the best-case NPV? Explain.
Multiple IRRs this problem is useful for testing the ability of financial calculators and computer software. Consider the following cash flows. How many different IRRs are there?
NPV Valuation The Yurdone Corporation wants to set up a private cemetery business. According to the CFO, Barry M. beep, business is “looking up.” As a result, the cemetery project will provide a
A project has the following cash flows: What is the IRR for this project? If the required return is 12 percent, should the firm accept the project? What is the NPV of this project? What is the NPV of
McKee kin Corp. has a project with the following cash flows: What is the IRR of the project? What is happening here?
NPV and IRR Anderson International Limited is evaluating a project in Erewhon. The project will create the following cash flows:All cash flows will occur in Erewhon and are expressed in dollars. In
Opportunity Cost In the context of capital budgeting, what is an opportunity cost?
Depreciation Given the choice, would a firm prefer to use MACRS depreciation or straight-line depreciation? Why?
Net Working Capital In our capital budgeting examples we assumed that a firm would recover all of the working capital it invested in a project. Is this a reasonable assumption? When might it not be
Stand-Alone Principle Suppose a financial manager is quoted as saying, “Our firm uses the standalone principle. Because we treat projects like mini firms in our evaluation process, we include
Equivalent Annual Cost When is EAC analysis appropriate for comparing two or more projects? Why is this method used? Are there any implicit assumptions required by this method that you find
Cash Flow and Depreciation “When evaluating projects, we’re concerned with only the relevant incremental after tax cash flows. Therefore, because depreciation is a noncash expense, we should
Capital Budgeting Considerations a major college textbook publisher has an existing finance textbook. The publisher is debating whether to produce an “essentialized” version, meaning a shorter
Erosion in evaluating the Cayenne, would you consider the possible damage to Porsche’s reputation erosion?
Capital Budgeting Porsche was one of the last manufacturers to enter the sports utility vehicle market. Why would one company decide to proceed with a product when other companies, at least
Capital Budgeting In evaluating the Cayenne, what do you think Porsche needs to assume regarding the substantial profit margins that exist in this market? Is it likely they will be maintained as the
Relevant Cash Flows Parker & Stone, Inc., is looking at setting up a new manufacturing plant in South Park to produce garden tools. The company bought some land six years ago for $5 million in
Relevant Cash Flows Winnebagel Corp. currently sells 30,000 motor homes per year at $45,000 each, and 12,000 luxury motor coaches per year at $85,000 each. The company wants to introduce a new
Calculating Projected Net Income A proposed new investment has projected sales of $740,000. Variable costs are 60 percent of sales, and fixed costs are $173,000; depreciation is $75,000. Prepare a
Calculating OCF Consider the following income statement: Fill in the missing numbers and then calculate the OCF. What is the depreciation tax shield?
OCF from Several Approaches A proposed new project has projected sales of $96,000, costs of $49,000, and depreciation of $4,500. The tax rate is 35 percent. Calculate operating cash flow using the

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