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Financial Management Theory and Practice 2nd Canadian edition Eugene Brigham, Michael Ehrhardt, Jerome Gessaroli, Richard Nason - Solutions

The real risk-free rate is 3%, and inflation is expected to be 3% for the next 2 years. A 2-year government security yields 6.3%. What is the maturity risk premium for the 2-year security?
Flipflop Footwear has issued bonds that have a 10% coupon rate, payable semiannually. The bonds mature in 6 years and have a face value of $1,000 and a yield to maturity of 5%. What is the price of the bonds?
Anthony has a choice of one of two bonds to purchase: a 5-year, $1,000 face value bond with 6% coupons, paid semiannually, or a 5-year, $1,000 face value zero coupon. Both have a yield to maturity of 5.5%.a. How much will each bond cost? b. How much would Anthony pay for similar bonds, assuming a
Is it possible to construct a portfolio of stocks that has an expected return equal to the risk- free rate?
Karen has the following portfolio:Upon further analysis, she determines that the current risk-free rate is 3%, while the market risk premium is 5%.a. What return does Karen expect on her portfolio, based on the individual stocks' expected returns?b. What is the required return on the portfolio?
You plan to invest in a hedge fund that has total capital of $500 million invested in five stocks:The risk-free rate is 6%, and you believe that the following probability distribution for future market returns is realistic:The hedge fund receives a proposal from a company seeking new capital. The
You have an $8 million portfolio consisting of a $400,000 investment in each of 20 different stocks. The portfolio has a beta equal to 1.1. You are considering selling $400,000 worth of one stock that has a beta equal to 0.9 and using the proceeds to purchase another stock that has a beta equal to
You are given the following data:From the above data, assume that you calculated Stock X's beta coefficient to be 0.56. a. Determine the arithmetic average rates of return for Stock X and the NYSE over the period given. Calculate the standard deviations of returns for both Stock X and the NYSE. b.
Assume that the risk-free rate is 4% and that the expected return on the market is 9%. What is the required rate of return on a stock that has a beta of 1.3?
Assume that the risk-free rate is 5% and the market risk premium is 6%. What is the expected return for the overall stock market? What is the required rate of return on a stock that has a beta of 1.2?
Assume that you recently graduated with a major in finance and that you have just landed a job as a financial planner with Barney Smith Inc., a large financial services corporation. Your first assignment is to invest $100,000 for a client. Because the funds are to be invested in a business at the
Two investors are evaluating Cogeco Cable's stock for possible purchase. They agree on the expected value of D1 and also on the expected future dividend growth rate. Furthermore, they agree on the risk of the stock. However, one investor normally holds stocks for 2 years, while the other normally
Data Services Corp. just paid a dividend of $2.25 a share (i.e., D0 = $2.25). The dividend is expected to grow 8% a year for the next 3 years, and then 10% a year thereafter. What is the expected dividend per share for each of the next 5 years?
Greenfield Environmental is expanding rapidly, and it currently needs to retain all of its earnings; hence it does not pay any dividends. However, investors expect Greenfield to begin paying dividends, with the first dividend of $0.40 coming 3 years from today. The dividend should grow rapidly-at a
Rolen Riders issued preferred stock with a stated dividend of 6% of par. Preferred stock of this type currently yields 7%, and the par value is $25. Assume dividends are paid annually.a. What is the value of Rolen's preferred stock? b. Suppose interest rate levels rise to the point where the
You buy a share of Bavarian Auto Parts Corp. stock for $33.44. You expect it to pay dividends of $3.01, $3.311, and $3.6421 in Years 1, 2, and 3, respectively, and you expect to sell it at a price of $44.51 at the end of 3 years. a. Calculate the growth rate in dividends.b. Calculate the expected
Brite-Lite Technologies (BLT) has just developed a solar panel capable of generating 200% more electricity than any solar panel currently on the market. As a result, BLT is expected to experience a 25% annual growth rate for the next 5 years. By the end of 5 years, other firms will have developed
Assume that today is December 31, 2012, and the following information applies to Pacific Sky Airline:• After-tax operating profit [EBIT (1-T), also called NOPAT] for 2013 is expected to be $500 million. • The net capital expenditures for 2013 are expected to be $100 million (depreciation has
Basil Pet Products has preferred stock outstanding that pays a dividend of $5 at the end of each year. The preferred stock sells for $50 a share. What is the preferred stock's required rate of return?
You are considering an investment in the common stock of Crisp's Cookware. The stock is expected to pay a dividend of $2 a share at the end of the year (D1 = $2.00). The stock has a beta equal to 0.9. The risk-free rate is 5.6%, and the market risk premium is 6%. The stock's dividend is expected
Skyline Aero stock is currently selling for $18 a share. The firm is expected to earn $1.98 per share this year and to pay a year-end dividend of $0.72.a. If investors require a 11% return, what rate of growth must be expected for Skyline Aero?b. If Skyline Aero reinvests earnings in projects with
Assume that a company has a target debt-to-equity capital structure of 2. The company currently pays 8% annually on its bonds. There are 10 years until maturity, and the bonds currently trade at 93% of par. Bond flotation costs are 3%. The company's beta is 1.5, the RPM = 4% and rRF = 5%. The
On January 1, the total market value of the Western Oil Co. was $100 million. During the year, the company plans to raise and invest $42 million in new projects. The firm's present market value debt-to-equity ratio is 1.8:1. Assume that there is no short-term debt. New bonds will have a 7% coupon
Your boss has asked you to estimate your company's WACC. You have assembled the following information:Beta ........................................................... 1.4Current stock price .......................................... $10Most recent dividend ....................................... $
Suppose the Churchill company has this book value balance sheet:The current liabilities consist entirely of notes payable to banks, and the interest rate on this debt is 4%, the same as the rate on new bank loans. The long-term debt consists of 47,000 bonds, each of which has a par value of
The balance sheet for NickelBack-Hoe Equipment Implements Inc. (NHE) is provided below along with other selected financial data.1. Short-term debt is permanent in nature. The company currently pays 6% and short-term borrowing costs are not expected to change over the next year. Short-term debt is
Long Haul Trucking can issue perpetual preferred stock at a price of $25 a share. The issue is expected to pay a constant annual dividend of $1.75 a share. Ignoring flotation costs, what is the company's cost of preferred stock, rps?
During the past few years, Harry Davis Industries has been too constrained by the high cost of capital to make many capital investments. Recently, though, capital costs have been declining, and the company has decided to look seriously at a major expansion program that has been proposed by the
Project A has a cost of $22,000 and is expected to produce benefits (cash flows) of $7,000 per year for 5 years. Project B costs $70,000 and is expected to produce cash flows of $20,000 per year for 5 years. Calculate the two projects' NPVs, IRRs, MIRRs, and PIs, assuming a cost of capital of
After discovering a new gold vein in central Ontario, CTC Mining Corporation must decide whether to mine the deposit. The most cost-effective method of mining gold is sulfuric acid extraction, a process that results in environmental damage. To go ahead with the extraction, CTC must spend $900,000
Seacraft Carriers is considering two alternative cargo ships. Ship A has an expected life of 7 years, will cost $60 million, and will produce net cash flows of $17 million per year. Ship B has a life of 14 years, will cost $75 million, and will produce net cash flows of $15 million per year.
a. What is capital budgeting?b. What is the difference between independent and mutually exclusive projects?c. 1. Define the term net present value (NPV). What is each franchise's NPV?2. What is the rationale behind the NPV method? According to NPV, which franchise or franchises should be accepted
Saint John River Shipyards is considering replacing an old riveting machine with a new one that will increase earnings before depreciation from $34,500 to $54,000 per year. The new machine will cost $92,500, and it will have an estimated life of 8 years with an estimated salvage value of $6,500.
The marketing department has proposed selling your company's product line in a new export market. Production equipment (Class 43) with a CCA rate of 30% costing $100,000 will be needed, as will installation and training estimated at $10,000 each. These costs will all occur at time 0. Project cash
Taylor Corporation currently uses an injection-moulding machine that was purchased 2 years ago. The CCA rate on this machine is 30%. Currently, it can be sold for $2,500. If this old machine is not replaced, it is not expected to have any value at the end of its useful life, estimated to be 6 years
Green Day Packers (GDP) purchased a computer for its back office operations in 2008 (Class 45, 45% CCA) for $5,000. Because of expanding operations, GDP purchased two additional computers in 2010 for $4,000 each. By 2011, the original computer was considered to be too slow and was sold for $800.
Nicola Company (NC) must decide between two mutually exclusive investment projects. Each project costs $17,500 and has an expected life of 3 years. Annual net cash flows from each project begin 1 year after the initial investment is made and have the following probability distributions:NC has
Metro Bottling Company is contemplating replacing one of its bottling machines with a newer and more efficient one. A just completed consultant's report, which cost Metro $12,000, provided the following rationale for the purchase.The old machine has a current value of $265,000 and a remaining
Yoran Yacht Company (YYC), a prominent sailboat builder in Victoria, B.C., is considering designing a new 30-foot sailboat based on the "winged" keels first introduced on the 12-metre yachts that raced for the America's Cup.First, YYC would have to invest $10,000 at t = 0 for the design and model
Zepplin Aerospace is trying to estimate the first-year operating cash flow (at t = 1) for a proposed project. The financial staff has collected the following information:Projected sales .......................... $65 millionOperating costs ......................... $39 millionCapital cost allowance
Fruity Fruits Ltd. currently sells $25 million annually of apple juice in 1 litre containers and $10 million of individually packaged dried fruit snacks. The company wants to intro- duce a 230 mL single-serving cranberry-apple juice product next year. A $200,000 feasibility study just completed
General Wireless has just completed market research on a new smart phone. This new phone is lighter and smaller, though more feature rich, than its existing product. New product sales are estimated at 1,000,000 units per year with a contribution margin of $40. However, if General Wireless
Red Rock Lobster (RRL) is looking to expand its business. The new business would generate $2.5 million per year in sales over the next 5 years. Annual costs would increase by Analysis $2.1 million. An investment in working capital of $50,000 would have to be made initially. The machinery (CCA rate
Ever Sparkle Company is considering an average-risk investment in a mineral water spring project that has a cost of $150,000. The project will produce 1,000 cases of mineral water per year indefinitely. The current sales price is $138 per case, and the current cost per case (all variable) is $105.
Nexus Toy Company is looking to introduce a new line of high end toy action figures. Below are the company's forecast financial data for the product: Price per unit ................................... $ 15 Quantity ......................................... 450, 000 Variable cost per
Central Drug Mart (CDM) is a drugstore chain operating in Ontario and Quebec. The company is contemplating a home delivery service for its prescription drug sales to customers who are unable to pick up their drugs in the stores. CDM is investigating whether to invest in small hybrid automobiles.
a. Define "incremental cash flow."1. Should you subtract interest expense or dividends when calculating project cash flow?2. Suppose the firm had spent $100,000 last year to rehabilitate the production line site. Should this cost be included in the analysis? Explain.3. Now assume that the plant
Rivoli Company has no debt outstanding, and its financial position is given by the following data:Assets (book = market) ........................... $3,000,000EBIT ................................................ $ 500,000Cost of equity, r,................................... 10%Stock price,
Air Kingston has just been incorporated, and its board of directors is currently grappling with the question of optimal capital structure. The company plans to offer commuter air services between Kingston and smaller surrounding cities. EagleAir has been around for a few years, and it has about the
Willard Pest Control (WPC) has a total market value of $40 million, consisting of 1 million shares selling for $20 per share and $20 million of 8% perpetual bonds now selling at par. The company's EBIT is $7.25 million, and its tax rate is 15%. WPC can change its capital structure by either
ARC Shipyards is considering a change in its capital structure. ARC currently has $20 million in debt carrying a rate of 8%, and its stock price is $24 per share with 5.1 million shares out- standing. ARC is a zero-growth firm and pays out all of its earnings as dividends. EBIT is $21.879 million,
Digital Design (DD) has a beta of 0.75. The tax rate is 30% and DD is financed with 40% debt. What is the company's unlevered beta?
B. Gibbs Inc. is an unleveraged firm, and it has constant expected operating earnings (EBIT) of $2 million per year. The firm's tax rate is 40%, and its market value is V = S = $12 million. Management is considering the use of some debt financing. (Debt would be issued and used to buy back stock,
Swift Foot Couriers has the following financial information:Debt: ......................... $0Book Equity: .............. $ 1,000,000Tax Rate: .................. 30%EBIT: ....................... 5200,000Swift Foot decides to borrow $500,000 at an 8% interest rate and, with the proceeds,
Quantum Computers Inc. produces mini super-computers that sell for $210,000 each. The firm's fixed costs, F, are $5 million; 200 super-computers are produced and sold each year; profits total $1.5 million and the firm's assets (all equity financed) are $10 million. The firm estimates that it can
a. Provide a brief overview of capital structure effects. Be sure to identify the ways in which capital structure can affect the weighted average cost of capital and free cash flows.b. (1) What is business risk? What factors influence a firm's business risk?(2) What is operating leverage, and
Titan Mining recently sold a piece of property for $15 million in cash. It wishes to return this money to shareholders and is contemplating either a special dividend or a repurchase of shares. Titan has net income of $5 million and 5,000,000 shares outstanding, and its stock trades at a P/E
Peninsula Technology Corporation (PTC) has an all-common-equity capital structure. It has 200,000 shares of $2 par value common stock outstanding. When PTC's founder, who was also its research director and most successful inventor, retired unexpectedly to the South Pacific in late 2012, PTC was
Aqua Adventures currently generates net income of $500,000 every year, all of which is paid out in dividends, and expects no future growth. Aqua has 200,000 shares outstanding, and investors require an 8% return on the company's shares. Assume that new management is hired to grow the company. One
Anthony and Sarah both invested in the common shares of two very similar companies. In fact, the only difference was that Sarah's stock of Northern Petroleum paid a regular dividend while Anthony's stock of Southern Petroleum repurchased shares instead. On seeing her first (of many) dividend
In 2012 the Keenan Company paid dividends totalling $850,000 on net income of $4.25 million. 2012 was a normal year, and for the past 10 years, earnings have grown at a constant rate of 6%. However, in 2013, earnings are expected to jump to $5.3 million, and the firm expects to have profitable
Tremblay Corporation is reviewing its capital budget for the upcoming year. It has paid a $3.00 dividend per share (DPS) for the past several years, and its shareholders expect the dividend to remain constant for the next several years. The company's target capital structure is 60% equity and 40%
TDM Company has a capital budget of $1,125,000. The company wants to maintain a target capital structure that is 20% debt and 80% equity. The company forecasts that its net income this year will be $2,000,000. If the company follows a residual distribution model and pays all distributions as
Wei Corporation expects next year's net income to be $15 million. The firm's debt ratio is currently 40%. Wei has $12 million of profitable investment opportunities, and it wishes to maintain its existing debt ratio. According to the residual distribution model (assuming all payments are in the
Eastern Shipping stock trades at $120 a share. The company is contemplating a 5-for-2 stock split. Assuming that the stock split will have no effect on the total market value of its equity, what will be the company's stock price following the stock split?
Saanich Heating and Cooling Inc. has a 6-month backlog of orders for its patented solar heating system. To meet this demand, management plans to expand production capacity by 40% with a $10 million investment in plant and machinery. The firm wants to maintain a 0.67 debt-equity ratio in its capital
Niagara Packers is considering three independent projects, each of which requires a $1.8 million investment. The estimated internal rate of return (IRR) and cost of capital for these projects are presented below:That the projects' cost of capital varies because the projects have different levels
Central Canada Steel (CCS) was formed 5 years ago to exploit a new continuous-casting process. CCS's founders, Donald Brown and Margo Lapointe, had been employed in the research department of a major integrated-steel company, but when that company decided against using the new process (which Brown
The securities commissions attempt to protect investors who are purchasing newly issued securities by making sure that the information put out by a company and its investment banks is correct and is not misleading. However, they do not provide an opinion about the real value of the securities;
Security Brokers Inc. completed a firm commitment underwriting for Beedles Inc. The terms were as follows:Price to public............................. $5 per shareNumber of shares......................... 3 millionProceeds to Beedles...................... $14,000,000The out-of-pocket expenses
Tundra Engineering, whose stock price is now $32, needs to raise $40 million in common stock. Underwriters have informed the firm's management that they must price the new issue to the public at $31 per share because of signalling effects. The underwriters' compensation will be 6% of the issue
Assume a company just sold 15,000, 000 shares in an IPO for $12 per share. If the underwriter took a 5% fee, and the company incurred $450,000 in legal and consulting costs:a. What net proceeds did the company and underwriters receive?b. How much money will be left on the table if at the end of the
Elie's Concrete Co. (ECC) currently has sales of $50 million and a net profit margin of 14%. Management is contemplating expansion, which would lead to sales growth of 8% but would also require raising $10 million through an equity issue. ECC's shares currently trade at $10.75, and its underwriter
Harbour Resources (HR) is contemplating an IPO. Their investment banker has provided the following information. The current risk-free rate in the market is 3%, while the market risk premium is 5%. Publicly traded companies in the same industry have betas ranging from 1.9 to 2.3. HR has paid
Advanced Composites Inc. (ACI) will be undertaking an IPO. The company needs to raise $90,000,000 net of all costs. ACI estimates this year's annual EPS to be $3.50. EPS is expected to grow by 6% thereafter. Although the company does not currently pay a dividend, it will begin to pay dividends
EastJet Airlines is an all-equity firm with a book value of $800,000,000 and 32,000,000 share outstanding. Its stock currently trades at $28 per share, and EPS is $4.60. EastJet wishes to issue another 2,000,000 shares to finance the development of a new reservation system. The new system will
Edelman Gem Company, a small jewellery manufacturer, has been successful and has enjoyed a good growth trend. Now Edelman is planning to go public with an issue of common stock, and it faces the problem of setting an appropriate price on the stock. The company and its investment banks believe that
Randy's, a family-owned restaurant chain operating in Montreal, has grown to the point where expansion throughout Quebec is feasible. The proposed expansion would require the firm to raise about $15 million in new capital. Because Randy's currently has a debt ratio of 50%, and also because the
Are lessees more likely than lessors to be in high- or low-income tax brackets?
Will ROI, debt to equity, and net income become smaller or larger if a lease is considered an operating lease as opposed to a capital lease?
Will a lessor likely charge higher or lower lease rates if the lessor's:a. Tax rate increase?b. Cost of borrowing increases?c. Residual value of the asst increases?d. Purchase price of the asset increases?Consider the impact of each separately?
Suppose there were no CRA rules governing leases and taxes. Explain, in a manner that a federal MP might understand, why some restrictions should be imposed. Illustrate your answer with numbers?
Minetello Construction needs a piece of equipment that costs $40,000. Minetello either can lease the equipment or borrow $40,000 from a local bank and buy the equipment. If the equipment is leased, the lease would not have to be capitalized. Minetello's balance sheet prior to the acquisition of
Assume in problem 15-1 that Minetello's tax rate is 40% and that the equipment's CCA would be $20,000 per year. If the company leased the asset on a 2-year lease, the payment would be $22,000 at the beginning of each year. If Minetello borrowed and bought, the bank would charge 10% interest on the
First Northern Minerals must install $3.9 million of new machinery in its Ontario mine. It can obtain a bank loan for 100% of the purchase price, or it can lease the machinery. Assume that the following facts apply:(1) The machinery falls into asset Class 38 with a declining balance CCA rate of
Howson Printing Ltd. (HPL) is looking at modernizing its facilities. As part of that process,HPL has decided to acquire new high-speed colour laser photocopiers. It has the option of buying the machines for $100,000 or leasing them for 5 years. HPL would be able to finance 100% of the purchase with
Alumco Industries must install $1 million of new computer equipment in its Ontario plant. It can obtain a bank loan for 100% of the required amount. Alternatively, Alumco believes that it can arrange for a lease financing plan. Assume that these facts apply:(1) The computer equipment falls into
Technical Service Corp (TSC) requires advanced controller software for its network monitoring system. The software can be purchased for $900,000 or leased out by Vancouver Leasing Inc. (VLI) over 3 years at $335,000 per year. The software will be obsolete and will have no value after 3 years. Since
Big Beta Securities Inc. has decided to acquire a new market data and quotation system for its Vancouver home office. The system receives current market prices and other information from several online data services and then either displays the information on a screen or stores it for later
How will the protection payment of a credit default swap change as the following variables change? Will the default swap protection payment increase, decrease, or remain unchanged?a. The expected recovery values decreaseb. The expected risk of default increasesc. The company the swap is based on
Pricing a CDO is very complicated and still not fully understood. What are some of the variables that you believe would be important in analyzing the price and the risk of a CDO?
Big City Bank enters into a credit default swap with LifeCo, a highly rated insurance company. The notional amount of the swap is $20 million. The 5-year swap is based on a 5-year loan to ABC Corp. The size of the protection payment is 2.78% per year. a. How much does Big City Bank pay LifeCo for
Delphi Analytics has warrants outstanding that permit the holders to purchase one share of stock per warrant at a price of $15. a. Calculate the exercise value of the firm's warrants if the common shares sell at each of the following prices: (1) $10, (2) $15, (3) $20, (4) $85. (Hint: A warrant's
A company issues a 10-year convertible bond with a 6% coupon, paid annually. The bond is convertible into common shares at a conversion rate of 55. Straight bonds of similar risk currently yield 7.8%. The stock price is currently priced 25% less than the conversion price. The company's stock price
The table below provides market data from February 27, 2012. Solve for the unknown variables. The "Premium" column refers to the percentage extra an investor would pay for the stock if it purchased the bond at the market price and immediately converted at the conversion ratio. Assume that the bonds
Fifteen years ago, Caleb Industries sold $400 million of convertible bonds. The bonds had a 40-year maturity and a 5.75% coupon rate and paid interest annually. They were sold at their $1,000 par value. The conversion price was set at $62.75; the common stock price was $55 per share. The bonds
Rossi's Tile and Ceramic Company has grown rapidly during the past 5 years. Recently, its commercial bank urged the company to consider increasing its permanent financing. Its bank loan under a line of credit has risen to $600,000, carrying a 7% interest rate. Rossi has been 30 to 60 days late in
Paul Duncan, financial manager of EduSoft Inc., is facing a dilemma. The firm was founded 5 years ago to provide educational software for the rapidly expanding primary and secondary school markets. Although EduSoft has done well, the firm's founder believes that an industry shakeout is imminent. To
Alain Jones recently obtained an equipment loan from a local bank. The loan is for $15,000 with a nominal interest rate of 11%. However, this is an installment loan, so the bank also charges add-on interest. Alain must make monthly payments on the loan, and the loan is to be repaid in 1 year. What
Del Hawley, owner of Hawley's Hardware, is negotiating with First City Bank for a 1-year loan of $50,000. First City has offered Hawley the following alternatives. Calculate the effective annual interest rate for each alternative. Which alternative has the lowest effective annual interest rate?a. A

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