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Questions and Answers of Finance

Define each of the following terms:a. Sole proprietorship; partnership; corporationb. Limited partnership; limited liability partnership; Professional Corporationc. Stockholder wealth maximizationd.
What are the three principal forms of business organization? What are the advantages and disadvantages of each?
What are the three primary determinants of a firm’s cash flow?
What are financial intermediaries, and what economic functions do they perform?
Which fluctuate more long-term or short-term interest rates? Why?
Suppose the population of Area Y is relatively young while that of Area O is relatively old, but everything else about the two areas is equal.a. Would interest rates likely be the same or different
Suppose a new and much more liberal Congress and administration were elected, and their first order of business was to take away the independence of the Federal Reserve System, and to force the Fed
Why is corporate finance important to all managers?
Describe the organizational forms a company might have as it evolves from a start-up to a major corporation. List the advantages and disadvantages of each form.
How do corporations “go public” and continue to grow? What are agency problems?
What should be the primary objective of managers?
Do firms have any responsibilities to society at large?
Is stock price maximization good or bad for society?
Should firms behave ethically?
The real risk-free rate of interest is 3 percent. Inflation is expected to be 2 percent this year and 4 percent during the next 2 years. Assume that the maturity risk premium is zero. What is the
A Treasury bond that matures in 10 years has a yield of 6 percent. A 10-year corporate bond has a yield of 8 percent. Assume that the liquidity premium on the corporate bond is 0.5 percent. What is
The real risk-free rate is 3 percent, and inflation is expected to be 3 percent for the next 2 years. A 2-year Treasury security yields 6.2 percent. What is the maturity risk premium for the 2-year
The real risk-free rate is 3 percent. Inflation is expected to be 3 percent this year, 4 percent next year, and then 3.5 percent thereafter. The maturity risk premium is estimated to be 0.0005 = (t =
Assume that the real risk-free rate, r*, is 3 percent and that inflation is expected to be 8 percent in Year 1, 5 percent in Year 2, and 4 percent thereafter. Assume also that all Treasury securities
Due to a recession, the inflation rate expected for the coming year is only 3 percent. However, the inflation rate in Year 2 and thereafter is expected to be constant at some level above 3 percent.
Suppose you and most other investors expect the inflation rate to be 7 percent next year, to fall to 5 percent during the following year, and then to remain at a rate of 3 percent thereafter. Assume
Define each of the following terms:a. PV; i; INT; FVn; PVAn; FVAn; PMT; m; iNomb. FVIFi,n; PVIFi,n; FVIFAi,n; PVIFAi,nc. Opportunity cost rated. Annuity; lump sum payment; cash flow; uneven cash
What is an opportunity cost rate? How is this rate used in discounted cash flow analysis, and where is it shown on a time line? Is the opportunity rate a single number that is used in all situations?
An annuity is defined as a series of payments of a fixed amount for a specific number of periods. Thus, $100 a year for 10 years is an annuity, but $100 in Year 1, $200 in Year 2, and $400 in Years 3
If a firm’s earnings per share grew from $1 to $2 over a 10-year period, the total growth would be 100 percent, but the annual growth rate would be less than 10 percent true or false? Explain.
Find the following values, using the equations, and then work the problems using a financial calculator to check your answers. Disregard rounding differences. (Hint: If you are using a financial
Use equations and a financial calculator to find the following values. See the hint for Problem 2-1.a. An initial $500 compounded for 10 years at 6 percent.b. An initial $500 compounded for 10 years
To the closest year, how long will it take $200 to double if it is deposited and earns the following rates? [Notes: (1) See the hint for Problem 2-1. (2) This problem cannot be solved exactly with
Find the future value of the following annuities. The first payment in these annuities is made at the end of Year 1; that is, they are ordinary annuities. (Note: See the hint to Problem 2-1. Also,
Find the present value of the following ordinary annuities (see note to Problem 2-4):a. $400 per year for 10 years at 10 percent.b. $200 per year for 5 years at 5 percent.c. $400 per year for 5 years
a. Find the present values of the following cash flow streams. The appropriate interest rate is 8 percent. It is fairly easy to work this problem dealing with the individual cash flows. However, if
Find the interest rates, or rates of return, on each of the following:a. You borrow $700 and promise to pay back $749 at the end of 1 year.b. You lend $700 and receive a promise to be paid $749 at
Find the amount to which $500 will grow under each of the following conditions:a. 12 percent compounded annually for 5 years.b. 12 percent compounded semiannually for 5 years.c. 12 percent compounded
Find the present value of $500 due in the future under each of the following conditions:a. 12 percent nominal rate, semiannual compounding, discounted back 5 years.b. 12 percent nominal rate,
Find the future values of the following ordinary annuities:a. FV of $400 each 6 months for 5 years at a nominal rate of 12 percent, compounded semiannually.b. FV of $200 each 3 months for 5 years at
(2-11) Universal Bank pays 7 percent interest, compounded annually, on time deposits.Regional Bank pays 6 percent interest, compounded quarterly.a. Based on effective interest rates, in which bank
a. Set up an amortization schedule for a $25,000 loan to be repaid in equal installments at the end of each of the next 5 years. The interest rate is 10 percent.b. How large must each annual payment
Hanebury Corporation’s current sales were $12 million. Sales were $6 million 5 years earlier.a. To the nearest percentage point, at what rate have sales been growing?b. Suppose someone calculated
Washington-Pacific invests $4 million to clear a tract of land and to set out some young pine trees. The trees will mature in 10 years, at which time Washington-Pacific plans to sell the forest at an
A mortgage company offers to lend you $85,000; the loan calls for payments of $8,273.59 per year for 30 years. What interest rate is the mortgage company charging you?
To complete your last year in business school and then go through law school, you will need $10,000 per year for 4 years, starting next year (that is, you will need to withdraw the first $10,000 one
While Mary Corns was a student at the University of Tennessee, she borrowed $12,000 in student loans at an annual interest rate of 9 percent. If Mary repays $1,500 per year, how long, to the nearest
You need to accumulate $10,000. To do so, you plan to make deposits of $1,250 per year, with the first payment being made a year from today, in a bank account that pays 12 percent annual interest.
What is the present value of perpetuity of $100 per year if the appropriate discount rate is 7 percent? If interest rates in general were to double and the appropriate discount rate rose to 14
Assume that you inherited some money. A friend of yours is working as an unpaid intern at a local brokerage firm, and her boss is selling some securities that call for four payments, $50 at the end
Assume that your aunt sold her house on December 31 and that she took a mortgage in the amount of $10,000 as part of the payment. The mortgage has a quoted (or nominal) interest rate of 10 percent,
Your company is planning to borrow $1,000,000 on a 5-year, 15%, annual payment, fully amortized term loan. What fraction of the payment made at the end of the second year will represent repayment of
a. It is now January 1. You plan to make 5 deposits of $100 each, one every 6 months, with the first payment being made today. If the bank pays a nominal interest rate of 12 percent but uses
Anne Lockwood, manager of Oaks Mall Jewelry, wants to sell on credit, giving customers 3 months in which to pay. However, Anne will have to borrow from her bank to carry the accounts payable. The
Assume that your father is now 50 years old, that he plans to retire in 10 years, and that he expects to live for 25 years after he retires, that is, until he is 85. He wants a fixed retirement
Define each of the following terms:a. Annual report; balance sheet; income statementb. Common stockholders’ equity, or net worth; retained earningsc. Statement of retained earnings; statement of
What four statements are contained in most annual reports?
If a “typical” firm reports $20 million of retained earnings on its balance sheet, could its directors declare a $20 million cash dividend without any qualms whatsoever?
What is operating capital, and why is it important?
Explain the difference between NOPAT and net income. Which is a better measure of the performance of a company’s operations?
What is free cash flow? Why is it the most important measure of cash flow?
If you were starting a business, what tax considerations might cause you to prefer to set it up as a proprietorship or a partnership rather than as a corporation?
An investor recently purchased a corporate bond which yields 9 percent. The investor is in the 36 percent combined federal and state tax bracket. What is the bond’s after-tax yield?
Corporate bonds issued by Johnson Corporation currently yield 8 percent. Municipal bonds of equal risk currently yield 6 percent. At what tax rate would an investor be indifferent between these two
The Talley Corporation had a taxable income of $365,000 from operations after all operating costs but before (1) interest charges of $50,000, (2) dividends received of $15,000, (3) dividends paid of
The Wendt Corporation had $10.5 million of taxable income.a. What is the company’s federal income tax bill for the year?b. Assume the firm receives an additional $1 million of interest income from
The Shrives Corporation has $10,000 that it plans to invest in marketable securities. It is choosing among AT&T bonds, which yield 7.5 percent, state of Florida mu ni bonds, which yield 5
The Klaven Corporation has operating income (EBIT) of $750,000. The company’s depreciation expense is $200,000. Klaven is 100 percent equity financed, and it faces a 40 percent tax rate. What is
The Menendez Corporation expects to have sales of $12 million. Costs other than depreciation are expected to be 75 percent of sales, and depreciation is expected to be $1.5 million. All sales
You have just obtained financial information for the past 2 years for Powell Panther Corporation. Answer the following questions.a. What is the net operating profit after taxes (NOPAT) for 2004?b.
The Herrmann Company has made $150,000 before taxes during each of the last 15 years, and it expects to make $150,000 a year before taxes in the future. However, in 2004 the firm incurred a loss of
Define the following terms, using graphs or equations to illustrate your answers wherever feasible:a. Stand-alone risk; risk; probability distributionb. Expected rate of return, rc. Continuous
The probability distribution of a less risky return is more peaked than that of a riskier return. What shape would the probability distribution have for?(a) Completely certain returns and(b)
Security A has an expected return of 7 percent, a standard deviation of returns of 35 percent, a correlation coefficient with the market of _0.3, and a beta coefficient of _1.5. Security B has an
Suppose you owned a portfolio consisting of $250,000 worth of long-term U.S. government bonds.a. Would your portfolio be risk less?b. Now suppose you hold a portfolio consisting of $250,000 worth of
If investors’ aversion to risk increased, would the risk premium on a high-beta stock increase more or less than that on a low-beta stock? Explain.
If a company’s beta were to double, would its expected return double?
Is it possible to construct a portfolio of stocks which has an expected return equal to the risk-free rate?
A stock's return has the following distribution:Calculate the stock's expected return, standard deviation, and coefficient of variation.
An individual has $35,000 invested in a stock which has a beta of 0.8 and $40,000 invested in a stock with a beta of 1.4. If these are the only two investments in her portfolio, what is her
Assume that the risk-free rate is 5 percent and the market risk premium is 6 percent. What is the expected return for the overall stock market? What is the required rate of return on a stock that
Assume that the risk-free rate is 6 percent and the expected return on the market is 13 percent. What is the required rate of return on a stock that has a beta of 0.7?
The market and Stock J have the following probability distributions:a. Calculate the expected rates of return for the market and Stock J.b. Calculate the standard deviations for the market and Stock
Suppose rRF = 5%, rM = 10%, and rA = 12%.a. Calculate Stock A’s beta.b. If Stock A’s beta were 2.0, what would be A’s new required rate of return?
Suppose rRF = 9%, rM = 14%, and bi = 1.3.a. What is ri, the required rate of return on Stock i?b. Now suppose rRF (1) increases to 10 percent or (2) decreases to 8 percent.The slope of the SML
Suppose you hold a diversified portfolio consisting of a $7,500 investment in each of 20 different common stocks. The portfolio beta is equal to 1.12. Now, suppose you have decided to sell one of the
Suppose you are the money manager of a $4 million investment fund. The fund consists of 4 stocks with the following investments and betas:If the market required rate of return is 14 percent and the
You have a $2 million portfolio consisting of a $100,000 investment in each of 20 different stocks. The portfolio has a beta equal to 1.1. You are considering selling $100,000 worth of one stock
Stock R has a beta of 1.5, Stock S has a beta of 0.75, the expected rate of return on an average stock is 13 percent, and the risk-free rate of return is 7 percent. By how much does the required
Stocks A and B have the following historical returns:a. Calculate the average rate of return for each stock during the 5-year period.b. Assume that someone held a portfolio consisting of 50 percent
You have observed the following returns over time:Assume that the risk-free rate is 6 percent and the market risk premium is 5 percent.a. What are the betas of Stocks X and Y?b. What are the required
Define the following terms, using graphs or equations to illustrate your answers wherever feasible:a. Portfolio; feasible set; efficient portfolio; efficient frontierb. Indifference curve; optimal
Security A has an expected rate of return of 6 percent, a standard deviation of expected returns of 30 percent, a correlation coefficient with the market of - 0.25, and a beta coefficient of 0.5.
a. Use a spreadsheet (or a calculator with a linear regression function) to determine Stock X's beta coefficient.b. Determine the arithmetic average rates of return for Stock X and the NYSE over the
You are given the following set of data:Construct a scatter diagram showing the relationship between returns on Stock Y and the market. Use a spreadsheet or a calculator with a linear regression
The beta coefficient of an asset can be expressed as a function of the asset's correlation with the market as follows:a. Substitute this expression for beta into the Security Market Line (SML),
Suppose you are given the following information. The beta of company i, bi, is 1.1, the risk-free rate, rRF, is 7 percent, and the expected market premium, rM - rRF, is 6.5 percent. (Assume that ai =
Define each of the following terms:a. Bond; Treasury bond; corporate bond; municipal bond; foreign bondb. Par value; maturity date; coupon payment; coupon interest ratec. Floating-rate bond; zero
“The values of outstanding bonds change whenever the going rate of interest changes. In general, short-term interest rates are more volatile than long-term interest rates. Therefore, short-term
The rate of return you would get if you bought a bond and held it to its maturity date is called the bond’s yield to maturity. If interest rates in the economy rise after a bond have been issued,
If you buy a callable bond and interest rates decline, will the value of your bond rise by as much as it would have risen if the bond had not been callable? Explain.
A sinking fund can be set up in one of two ways:(1) The corporation makes annual payments to the trustee, who invests the proceeds in securities (frequently government bonds) and uses the accumulated
Callaghan Motors’ bonds have 10 years remaining to maturity. Interest is paid annually, the bonds have a $1,000 par value, and the coupon interest rate is 8 percent. The bonds have a yield to
Wilson Wonders’ bonds have 12 years remaining to maturity. Interest is paid annually, the bonds have a $1,000 par value, and the coupon interest rate is 10 percent. The bonds sell at a price of
Thatcher Corporation’s bonds will mature in 10 years. The bonds have a face value of $1,000 and an 8 percent coupon rate, paid semiannually. The price of the bonds is $1,100. The bonds are

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