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Questions and Answers of Finance

What is interest rate parity? Currently, you can exchange 1 yen for 0.0095 U.S. dollar in the 30-day forward market, and the risk-free rate on 30-day securities is 4% in both Japan and the United
What is purchasing power parity (PPP)? 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 Australia?
What effect does relative inflation have on interest rates and exchange rates?
Briefly explain the three major types of international credit markets.
Briefly explain how ADRs work.
To what extent do average capital structures vary across different countries? Discuss.
What is the effect of multinational operations on capital budgeting decisions. Discuss.
The management of Mitchell Labs decided to go private in 2002 by buying in all 3 million of its outstanding shares at $19.50 per share. By 2006, management had restructured the company by selling off
What is risk in the context of financial decision making?
Define return, and describe how to find the rate of return on an investment.
Compare the following risk preferences: (a) Risk averse, (b) Risk neutral, and (c) Risk seeking. Which is most common among financial managers?
Explain how the range is used in scenario analysis.
What does a plot of the probability distribution of outcomes show a decision maker about an asset’s risk?
What relationship exists between the size of the standard deviation and the degree of asset risk?
What does the coefficient of variation reveal about an investment’s risk that the standard deviation does not?
What is an efficient portfolio? How can the return and standard deviation of a portfolio be determined?
Why is the correlation between asset returns important? How does diversification allow risky assets to be combined so that the risk of the portfolio is less than the risk of the individual assets in
How does international diversification enhance risk reduction? When might international diversification result in subpar returns? What are political risks, and how do they affect international
How are total risk, nondiversifiable risk, and diversifiable risk related? Why is nondiversifiable risk the only relevant risk?
What risk does beta measure? How can you find the beta of a portfolio?
Explain the meaning of each variable in the capital asset pricing model (CAPM) equation. What is the security market line (SML)?
What impact would the following changes have on the security market line and therefore on the required return for a given level of risk? (a) An increase in inflationary expectations. (b) Investors
An analyst predicted last year that the stock of Logistics, Inc., would offer a total return of at least 10 % in the coming year. At the beginning of the year, the firm had a stock market value of
Four analysts cover the stock of Fluorine Chemical. One forecasts a 5% return for the coming year. A second expects the return to be negative 5%. A third predicts a 10% return. A fourth expects a 3%
The expected annual returns are 15% for investment 1 and 12% for investment 2. The standard deviation of the first investment’s return is 10%; the second investment’s return has a standard
Your portfolio has three asset classes. U.S. government T-bills account for 45% of the portfolio, large-company stocks constitute another 40%, and small-company stocks make up the remaining 15%. If
You wish to calculate the risk level of your portfolio based on its beta. The five stocks in the portfolio with their respective weights and betas are shown in the accompanying table. Calculate the
a. Calculate the required rate of return for an asset that has a beta of 1.8, given a risk-free rate of 5% and a market return of 10%.b. If investors have become more risk-averse due to recent
Douglas Keel, a financial analyst for Orange Industries, wishes to estimate the rate of return for two similar-risk investments, X and Y. Douglas’s research indicates that the immediate past
For each of the investments shown in the following table, calculate the rate of return earned over the unspecified timeperiod.
Sharon Smith, the financial manager for Barnett Corporation, wishes to evaluate three prospective investments: X, Y, and Z. Sharon will evaluate each of these investments to decide whether they are
Solar Designs is considering an investment in an expanded product line. Two possible types of expansion are being considered. After investigating the possible outcomes, the company made the estimates
Micro-Pub, Inc., is considering the purchase of one of two microfilm cameras, R and S. Both should provide benefits over a 10-year period, and each requires an initial investment of $4,000.
Swan's Sportswear is considering bringing out a line of designer jeans. Currently, it is negotiating with two different well-known designers. Because of the highly competitive nature of the industry,
Metal Manufacturing has isolated four alternatives for meeting its need for increased production capacity. The following table summarizes data gathered relative to each of these alternatives.a.
Greengage, Inc., a successful nursery, is considering several expansion projects. All of the alternatives promise to produce an acceptable return. Data on four possible projects follow.a. Which
Mike is searching for a stock to include in his current stock portfolio. He is interested in Hi-Tech Inc.; he has been impressed with the company€™s computer products and believes Hi-Tech
Swift Manufacturing must choose between two asset purchases. The annual rate of return and the related probabilities given in the following table summarize the firm's analysis to this point.a. For
Three assets'F, G, and H'are currently being considered by Perth Industries. The probability distributions of expected returns for these assets are shown in the following table.a. Calculate the
Assuming that the rates of return associated with a given asset investment are normally distributed; that the expected return, rˉ, is 18.9%; and that the coefficient of variation, CV, is 0.75;
Jamie Wong is considering building an investment portfolio containing two stocks, L and M. Stock L will represent 40% of the dollar value of the portfolio, and stock M will account for the other 60%.
You have been given the expected return data shown in the first table on three assets'F, G, and H'over the period 2013â€“2016.Using these assets, you have isolated the three investment
Matt Peters wishes to evaluate the risk and return behaviors associated with various combinations of assets V and W under three assumed degrees of correlation: perfect positive, uncorrelated, and
International investment returns Joe Martinez, a U.S. citizen living in Brownsville, Texas, invested in the common stock of Telmex, a Mexican corporation. He purchased 1,000 shares at 20.50 pesos per
David Talbot randomly selected securities from all those listed on the New York Stock Exchange for his portfolio. He began with a single security and added securities one by one until a total of 20
A firm wishes to estimate graphically the betas for two assets, A and B. It has gathered the return data shown in the following table for the market portfolio and for both assets over the last 10
Graphical derivation and interpreting beta You are analyzing the performance of two stocks. The first, shown in Panel A, is Cyclical Industries Incorporated. CyclicalIndustries makes machine tools
A firm wishes to assess the impact of changes in the market return on an asset that has a beta of 1.20.a. If the market return increased by 15%, what impact would this change be expected to have on
Answer the questions below for assets A to D shown in the table.Asset BetaA ...... 0.50B ...... 1.60C ...... 0.20D ...... 0.90a. What impact would a 10% increase in the market return be expected
You are considering three stocks—A, B, and C—for possible inclusion in your investment portfolio. Stock A has a beta of 0.80, stock B has a beta of 1.40, and stock C has a beta of 0.30.a. Rank
Rose Berry is attempting to evaluate two possible portfolios, which consist of the same five assets held in different proportions. She is particularly interested in using beta to compare the risks of
For each of the cases shown in the following table, use the capital asset pricing model to find the requiredreturn.
Beta coefficients and the capital asset pricing model Katherine Wilson is wondering how much risk she must undertake to generate an acceptable return on her portfolio. The risk-free return
Use the basic equation for the capital asset pricing model (CAPM) to work each of the following problems.a. Find the required return for an asset with a beta of 0.90 when the risk-free rate and
Jamie Peters invested $100,000 to set up the following portfolio one year ago:a. Calculate the portfolio beta on the basis of the original cost figures.b. Calculate the percentage return of each
Assume that the risk-free rate, RF, is currently 9% and that the market return, rm, is currently 13%.a. Draw the security market line (SML) on a set of “nondiversifiable risk (x axis)–required
Assume that the risk-free rate, RF, is currently 8%, the market return, rm, is 12%, and asset A has a beta, bA, of 1.10.a. Draw the security market line (SML) on a set of “nondiversifiable risk (x
Wolff Enterprises must consider several investment projects, A through E, using the capital asset pricing model (CAPM) and its graphical representation, the security market line (SML). Relevant
Risk is a major concern of almost all investors. When shareholders invest their money in a firm, they expect managers to take risks with those funds. What do you think are the ethical limits that
What is the cost of capital?
What role does the cost of capital play in the firm’s long-term investment decisions? How does it relate to the firm’s ability to maximize shareholder wealth?
What does the firm’s capital structure represent?
What are the typical sources of long-term capital available to the firm?
What are the net proceeds from the sale of a bond? What are flotation costs, and how do they affect a bond’s net proceeds?
What methods can be used to find the before-tax cost of debt?
How is the before-tax cost of debt converted into the after-tax cost?
How would you calculate the cost of preferred stock?
What premise about share value underlies the constant-growth valuation (Gordon growth) model that is used to measure the cost of common stock equity, rs?
How do the constant-growth valuation model and capital asset pricing model methods for finding the cost of common stock differ?
Why is the cost of financing a project with retained earnings less than the cost of financing it with a new issue of common stock?
What is the weighted average cost of capital (WACC), and how is it calculated?
What is the relationship between the firm’s target capital structure and the weighted average cost of capital (WACC)?
Describe the logic underlying the use of target weights to calculate the WACC, and compare and contrast this approach with the use of historical weights. What is the preferred weighting scheme?
A firm raises capital by selling $20,000 worth of debt with flotation costs equal to 2% of its par value. If the debt matures in 10 years and has a coupon interest rate of 8%, what is the bond’s
Your firm, People’s Consulting Group, has been asked to consult on a potential preferred stock offering by Brave New World. This 15% preferred stock issue would be sold at its par value of $35 per
Duke Energy has been paying dividends steadily for 20 years. During that time, dividends have grown at a compound annual rate of 7%. If Duke Energy’s current stock price is $78 and the firm plans
Weekend Warriors, Inc., has 35% debt and 65% equity in its capital structure. The firm’s estimated after-tax cost of debt is 8% and its estimated cost of equity is 13%. Determine the firm’s
Oxy Corporation uses debt, preferred stock, and common stock to raise capital. The firm’s capital structure targets the following proportions: debt, 55%; preferred stock, 10%; and common stock,
Wren Manufacturing is in the process of analyzing its investment decision-making procedures. The two projects evaluated by the firm during the past month were projects 263 and 264. The basic
Currently, Warren Industries can sell 15-year, $1,000-par-value bonds paying annual interest at a 12% coupon rate. As a result of current interest rates, the bonds can be sold for $1,010 each;
David Abbot is interested in purchasing a bond issued by Sony. He has obtained the following information on the security:Answer the following questions.a. Calculate the before-tax cost of the Sony
For each of the following $1,000-par value bonds, assuming annual interest payment and a 40% tax rate, calculate the after-tax cost to maturity using the approximation formula.
Gronseth Drywall Systems, Inc., is in discussions with its investment bankers regarding the issuance of new bonds. The investment banker has informed the firm that different maturities will carry
Rick and Stacy Stark, a married couple, are interested in purchasing their first boat. They have decided to borrow the boat’s purchase price of $100,000. The family is in the 28% federal income tax
Taylor Systems has just issued preferred stock. The stock has a 12% annual dividend and a $100 par value and was sold at $97.50 per share. In addition, flotation costs of $2.50 per share must be
Determine the cost for each of the following preferredstocks.
J&M Corporation common stock has a beta, b, of 1.2. The risk-free rate is 6%, and the market return is 11%.a. Determine the risk premium on J&M common stock.b. Determine the required return that J&M
Ross Textiles wishes to measure its cost of common stock equity. The firm’s stock is currently selling for $57.50. The firm expects to pay a $3.40 dividend at the end of the year (2013). The
Using the data for each firm shown in the following table, calculate the cost of retained earnings and the cost of new common stock using the constant-growth valuation model.
Equity Lighting Corp. wishes to explore the effect on its cost of capital of the rate at which the company pays taxes. The firm wishes to maintain a capital structure of 30% debt, 10% preferred
Ridge Tool has on its books the amounts and specific (after-tax) costs shown in the following table for each source of capital.a. Calculate the firm€™s weighted average cost of capital
Webster Company has compiled the information shown in the following table.a. Calculate the weighted average cost of capital using book value weights.b. Calculate the weighted average cost of
After careful analysis, Dexter Brothers has determined that its optimal capital structure is composed of the sources and target market value weights shown in the following table.The cost of debt
Edna Recording Studios, Inc., reported earnings available to common stock of $4,200,000 last year. From those earnings, the company paid a dividend of $1.26 on each of its 1,000,000 common shares
Dillon Labs has asked its financial manager to measure the cost of each specific type of capital as well as the weighted average cost of capital. The weighted average cost is to be measured by using
John Dough has just been awarded his degree in business. He has three education loans outstanding. They all mature in 5 years and can be repaid without penalty any time before maturity. The amounts
Since its inception, Eco Plastics Company has been revolutionizing plastic and trying to do its part to save the environment. Eco’s founder, Marion Cosby, developed a biodegradable plastic that her
What is the financial manager’s goal in selecting investment projects for the firm? Define the capital budgeting process and explain how it helps managers achieve their goal.
What is the payback period? How is it calculated?
What weaknesses are commonly associated with the use of the payback period to evaluate a proposed investment?

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