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Corporate Finance
Turner Video will invest $58,500 in a project. The firm’s cost of capital is 12 percent. The investment will provide the following inflows.Year Inflow1 ........$15,0002 ........ 17,0003
The Caffeine Coffee Company uses the modified internal rate of return. The firm has a cost of capital of 11 percent. The project being analyzed is as follows ($26,000 investment):YearCash Flow1
The Suboptimal Glass Company uses a process of capital rationing in its decision making. The firm€™s cost of capital is 10 percent. It will only invest $77,000 this year. It has determined the
Keller Construction is considering two new investments. Project E calls for the purchase of earthmoving equipment. Project H represents an investment in a hydraulic lift. Keller wishes to use a net
Davis Chili Company is considering an investment of $35,000, which produces the following inflows:YearCash Flow1 .......$16,0002 ....... 15,0003 ....... 12,000You are going to use the net present
Telstar Communications is going to purchase an asset for $380,000 that will produce $180,000 per year for the next four years in earnings before depreciation and taxes. The asset will be depreciated
Assume $65,000 is going to be invested in each of the following assets. Using Tables 12-11 and 12-12, indicate the dollar amount of the first year’s depreciation.a. Office furniture.b.
The Summit Petroleum Corporation will purchase an asset that qualifies for three-year MACRS depreciation. The cost is $160,000 and the asset will provide the following stream of earnings before
Oregon Forest Products will acquire new equipment that falls under the five-year MACRS category. The cost is $300,000. If the equipment is purchased, the following earnings before depreciation and
Universal Electronics is considering the purchase of manufacturing equipment with a 10-year midpoint in its asset depreciation range (ADR). Carefully refer to Table 12-11 to determine in what
The Spartan Technology Company has a proposed contract with the Digital Systems Company of Michigan. The initial investment in land and equipment will be $120,000. Of this amount, $70,000 is subject
An asset was purchased three years ago for $120,000. It falls into the five-year category for MACRS depreciation. The firm is in a 35 percent tax bracket. Compute the following:a. Tax loss on the
DataPoint Engineering is considering the purchase of a new piece of equipment for $240,000. It has an eight-year midpoint of its asset depreciation range (ADR). It will require an additional initial
Hercules Exercise Equipment Co. purchased a computerized measuring device two years ago for $58,000. The equipment falls into the five-year category for MACRS depreciation and can currently be sold
Al Quick, the president of a New York Stock Exchange-listed firm, is very short-term oriented and interested in the immediate consequences of his decisions. Assume a project that will provide an
The Woodruff Corporation purchased a piece of equipment three years ago for $230,000. It has an asset depreciation range (ADR) midpoint of eight years. The old equipment can be sold for $90,000. A
Discuss the concept of risk and how it might be measured.
Explain how the concept of risk can be incorporated into the capital budgeting process.
If risk is to be analyzed in a qualitative way, place the following investment decisions in order from the lowest risk to the highest risk:a. New equipmentb. New marketc. Repair of old machineryd.
What is the purpose of using simulation analysis?
When is the coefficient of variation a better measure of risk than the standard deviation?
Assume a firm has several hundred possible investments and that it wants to analyze the risk-return trade-off for portfolios of 20 projects. How should it proceed with the evaluation?
Explain the effect of the risk-return trade-off on the market value of common stock.
Assume you are risk-averse and have the following three choices. Which project will you select? Compute the coefficient of variation foreach.
Myers Business Systems is evaluating the introduction of a new product. The possible levels of unit sales and the probabilities of their occurrence are given next:a. What is the expected value of
Sampson Corp. is evaluating the introduction of a new product. The possible levels of unit sales and the probabilities of their occurrence are given.a. What is the expected value of unit sales for
Shack Homebuilders Limited is evaluating a new promotional campaign that could increase home sales. Possible outcomes and probabilities of the outcomes are shown next. Compute the coefficient
Al Bundy is evaluating a new advertising program that could increase shoe sales. Possible outcomes and probabilities of the outcomes are shown next. Compute the coefficient ofvariation.
Possible outcomes for three investment alternatives and their probabilities of occurrence are given next.Rank the three alternatives in terms of risk from lowest to highest (compute the coefficient
Five investment alternatives have the following returns and standard deviations of returns.Using the coefficient of variation, rank the five alternatives from lowest risk to highestrisk.
Five investment alternatives have the following returns and standard deviations of returns.Using the coefficient of variation, rank the five alternatives from lowest risk to highestrisk.
Digital Technology wishes to determine its coefficient of variation as a company over time. The firm projects the following data (in millions of dollars):a. Compute the coefficient of variation (V)
Tim Trepid is highly risk-averse, while Mike Macho actually enjoys taking a risk.a. Which one of the four investments should Tim choose? Compute coefficients of variation to help you in your
Mountain Ski Corp. was set up to take large risks and is willing to take the greatest risk possible. Lakeway Train Co. is more typical of the average corporation and is risk-averse.a. Which of the
Kyle’s Shoe Stores Inc. is considering opening an additional suburban outlet. An aftertax expected cash flow of $130 per week is anticipated from two stores that are being evaluated. Both
Waste Industries is evaluating a $70,000 project with the following cash flows.Year Cash Flows1 ......... $11,0002 ......... 16,0003 ......... 21,0004 ......... 24,0005
Dixie Dynamite Company is evaluating two methods of blowing up old buildings for commercial purposes over the next five years. Method one (implosion) is relatively low in risk for this business and
Fill in the following table from Appendix B. Does a high discount rate have a greater or lesser effect on long-term inflows compared to recentones?
Debby’s Dance Studios is considering the purchase of new sound equipment that will enhance the popularity of its aerobics dancing. The equipment will cost $27,900. Debby is not sure how many
Highland Mining and Minerals Co. is considering the purchase of two gold mines. Only one investment will be made. The Australian gold mine will cost $1,649,000 and will produce $353,000 per year in
Mr. Sam Golff desires to invest a portion of his assets in rental property. He has narrowed his choices down to two apartment complexes, Palmer Heights and Crenshaw Village. After conferring with the
Allison€™s Dresswear Manufacturers is preparing a strategy for the fall season. One alternative is to expand its traditional ensemble of wool sweaters. A second option would be to enter the
When returns from a project can be assumed to be normally distributed, such as those shown in Figure (represented by a symmetrical, bell-shaped curve), the areas under the curve can be determined
The Oklahoma Pipeline Company projects the following pattern of inflows from an investment. The inflows are spread over time to reflect delayed benefits. Each year is independent of the others.The
Treynor Pie Company is a food company specializing in high-calorie snack foods. It is seeking to diversify its food business and lower its risks. It is examining three companies—a gourmet
Hooper Chemical Company, a major chemical firm that uses such raw materials as carbon and petroleum as part of its production process, is examining a plastics firm to add to its operations. Before
Ms. Sharp is looking at a number of different types of investments for her portfolio. She identifies eight possible investments.a. Graph the data in a manner similar to Figure. Use the axes that
Sheila Goodman recently received her MBA from the Harvard Business School. She has joined the family business, Goodman Software Products Inc., as Vice-President of Finance. She believes in adjusting
Gibson Appliance Co. is a very stable billion-dollar company with a sales growth of about 7 percent per year in good or bad economic conditions. Because of this stability (a coefficient of
Five years ago, Kennedy Trucking Company was considering the purchase of 60 new diesel trucks that were 15 percent more fuel-efficient than the ones the firm is now using. Mr. Hoffman, the president,
Why does capital budgeting rely on analysis of cash flows rather than on net income?
Why do we use the overall cost of capital for investment decisions even when only one source of capital will be used (e.g., debt)?
In computing the cost of capital, do we use the historical costs of existing debt and equity or the current costs as determined in the market? Why?
Why is the cost of issuing new common stock (Kn) higher than the cost of retained earnings (Ke)?
Explain the traditional, U-shaped approach to the cost of capital.
It has often been said that if the company can’t earn a rate of return greater than the cost of capital, it should not make investments. Explain.
What effect would inflation have on a company’s cost of capital? (Hint: Think about how inflation influences interest rates, stock prices, corporate profits, and growth.)
What is the concept of marginal cost of capital?
Why is the cost of debt less than the cost of preferred stock if both securities are priced to yield 10 percent in the market?
In March 2010, Hertz Pain Relievers bought a massage machine that provided a return of 8 percent. It was financed by debt costing 7 percent. In August 2010, Mr. Hertz came up with a heating compound
Speedy Delivery Systems can buy a piece of equipment that is anticipated to provide an 11 percent return and can be financed at 6 percent with debt. Later in the year, the firm turns down an
A brilliant young scientist is killed in a plane crash. It is anticipated that he could have earned $240,000 a year for the next 50 years. The attorney for the plaintiff’s estate argues that the
Telecom Systems can issue debt yielding 9 percent. The company is in a 30 percent bracket. What is its after-tax cost of debt?
Calculate the after-tax cost of debt under each of the followingconditions.
Calculate the after-tax cost of debt under each of the followingconditions.
The Goodsmith Charitable Foundation, which is tax-exempt, issued debt last year at 9 percent to help finance a new playground facility in Los Angeles. This year the cost of debt is 25 percent
Royal Jewelers Inc. has an aftertax cost of debt of 7 percent. With a tax rate of 35 percent, what can you assume the yield on the debt is?
Airborne Airlines Inc. has a $1,000 par value bond outstanding with 25 years to maturity. The bond carries an annual interest payment of $88 and is currently selling for $950. Airborne is in a 40
Russell Container Corporation has a $1,000 par value bond outstanding with 30 years to maturity. The bond carries an annual interest payment of $105 and is currently selling for $880 per bond.
Terrier Company is in a 40 percent tax bracket and has a bond outstanding that yields 10 percent to maturity.a. What is Terrier’s aftertax cost of debt?b. Assume that the yield on the bond goes
KeySpan Corp. is planning to issue debt that will mature in 2035. In many respects, the issue is similar to the currently outstanding debt of the corporation. Using Table 11-2, identify:a. The yield
Medco Corporation can sell preferred stock for $90 with an estimated flotation cost of $2. It is anticipated the preferred stock will pay $8 per share in dividends.a. Compute the cost of preferred
The treasurer of Riley Coal Co. is asked to compute the cost of fixed income securities for her corporation. Even before making the calculations, she assumes the aftertax cost of debt is at least 3
Murray Motor Company wants you to calculate its cost of common stock. During the next 12 months, the company expects to pay dividends (D1) of $2.50 per share, and the current price of its common
Compute Ke and Kn under the following circumstances:a. D1 = $5.00, P0 = $70, g = 8%, F = $7.00.b. D1 = $0.22, P0 = $28, g = 7%, F = $2.50.c. E1 (earnings at the end of period one) = $7, payout ratio
Business has been good for Keystone Control Systems, as indicated by the four-year growth in earnings per share. The earnings have grown from $1.00 to $1.63.a. Use Appendix A at the back of the text
Global Technology’s capital structure is as follows:Debt ............35%Preferred stock ........15Common equity .......50The aftertax cost of debt is 6.5 percent; the cost of preferred stock is
Evans Technology has the following capital structure.Debt ............. 40%Common equity ....... 60The aftertax cost of debt is 6 percent; and the cost of common equity (in the form of retained
Sauer Milk Inc. wants to determine the minimum cost of capital point for the firm. Assume it is considering the following financial plans:a. Which of the four plans has the lowest weighted average
Given the following information, calculate the weighted average cost of capital for Hamilton Corp. Line up the calculations in the order shown in Table.Percent of capital structure:Debt
Given the following information, calculate the weighted average cost of capital for Digital Processing Inc. Line up the calculations in the order shown in Table.Percent of capital
Brook’s Window Shields Inc. is trying to calculate its cost of capital for use in a capital budgeting decision. Mr. Glass, the vice-president of finance, has given you the following information
A-Rod Manufacturing Company is trying to calculate its cost of capital for use in making a capital budgeting decision. Mr. Jeter, the vice-president of finance, has given you the following
Northwest Utility Company faces increasing needs for capital. Fortunately, it has an Aa3 credit rating. The corporate tax rate is 40 percent. Northwest€™s treasurer is trying to determine the
Delta Corporation has the following capital structure:a. If the firm has $18 million in retained earnings, at what size capital structure will the firm run out of retained earnings?b. The 8.1 percent
The Nolan Corporation finds it is necessary to determine its marginal cost of capital. Nolan’s current capital structure calls for 50 percent debt, 30 percent preferred stock, and 20 percent
The McGee Corporation finds it is necessary to determine its marginal cost of capital. McGee’s current capital structure calls for 40 percent debt, 30 percent preferred stock, and 30 percent
Eaton Electronic Company’s treasurer uses both the capital asset pricing model and the dividend valuation model to compute the cost of common equity (also referred to as the required rate of
Medical Research Corporation is expanding its research and production capacity to introduce a new line of products. Current plans call for the expenditure of $100 million on four projects of equal
Masco Oil and Gas Company is a very large company with common stock listed on the New York Stock Exchange and bonds traded over the counter. As of the current balance sheet, it has three bond issues
How does the capital asset pricing model help explain changing costs of capital?
How does the SML react to changes in the rate of interest, changes in the rate of inflation, and changing investor expectations?
Assume that Rf = 5 percent and Km = 10.5 percent. Compute Kj for the following betas using Formula 11A-2.a. 0.6b. 1.3c. 1.9
Assume that Rf = 6 percent and the market risk premium (Km – Rf) is 7.0 percent. Compute Kj for the following betas using Formula 11A-2.a. 0.6b. 1.3c. 1.9
How does the marginal principle of retained earnings relate to the returns that a stockholder may make in other investments?
Discuss the difference between a passive and an active dividend policy.
How does the stockholder, in general, feel about the relevance of dividends?
Explain the relationship between a company’s growth possibilities and its dividend policy.
Since initial contributed capital theoretically belongs to the stockholders, why are there legal restrictions on paying out the funds to the stockholders?
Discuss how desire for control may influence a firm’s willingness to pay dividends.
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