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Financial Management Principles and Applications 13th edition Sheridan Titman, Arthur J. Keown, John H. Martin - Solutions

While you are home for fall break, your grandfather tells you that he has purchased the stock of two firms in the automobile industry: Toyota and Ford. He goes on to discuss the merits of his decision, and one of the points he makes is that he has avoided the risk of purchasing only one company's
True or false: Portfolio diversification is affected by the volatility of the returns of the individual investments in the portfolio as well as by the correlation among the returns. Explain.
Describe what is meant by systematic and unsystematic risk. How is this distinction related to an investment's beta?
What is the security market line? What do the slope and intercept of this line represent?
Describe what the Capital Asset Pricing Model tells you to your father, who has never had a course in finance. What is the key insight we gain from this model?
Two recent graduates from business school (Mark Van and Sheila Epps) decided to set up an investment company to acquire home mortgages that are in default but that they hope to restructure in ways that make it possible for the homeowner to continue making payments and thus retain ownership of their
Mark and Sheila from Problem 8-1 are trying to apply their understanding of the security market line concept to the analysis of their real estate investment strategy. They estimate that their portfolio will have an expected rate of return of 8.25%.a. If the risk-free rate of interest is currently
Sante Capital operates two mutual funds headquartered in Houston, Texas. The firm is evaluating the stock of four different firms for possible inclusion in its fund holdings. As part of their analysis, Sante's managers have asked their junior analyst to estimate the investor-required rate of
Breckenridge, Inc., has a beta of .85. If the expected market portfolio return is 10.5 percent and the risk-free rate is 3.5 percent, what is the appropriate expected return of Breckenridge (using the CAPM)?
Mary Guilott recently graduated from Nichols State University and is anxious to begin investing her meager savings as a way of applying what she has learned in business school. Specifically, she is evaluating an investment in a portfolio comprised of two firms' common stock. She has collected the
Penny Francis inherited a $200,000 portfolio of investments from her grandparents when she turned 21 years of age. The portfolio is comprised of treasury bills and stock in Ford (F) and Harley Davidson (HOG):____________________________________Expected Return ________$ ValueTreasury bills
Bronc Gerson is 60 years of age and is considering retirement. Bronc got his name from the fact that as a young man he spent several years in the rodeo circuit competing as a bareback rider. His retirement portfolio currently is valued at $950,000 and is allocated in Treasury bills, an S&P 500
After a tumultuous period in the stock market, Logan Morgan is considering an investment in one of two portfolios. Given the information that follows, which investment is better, based on risk (as measured by the standard deviation) and return as measured by the expected rate of return?
What does a bond rating reflect? Why is the rating important to the firm's management?
Distinguish between the following: a. Debentures and mortgage bonds b. Eurobonds, zero-coupon bonds, and junk bonds c. Premium and discount bonds
Why does the market value of a bond differ from its par value when the coupon interest rate does not equal the market yield to maturity on a comparable-risk bond?
Is the price of a long-term (longer-maturity) bond more or less sensitive to changes in interest rates than that of a short-term bond? Why?
How does inflation impact the rate of interest observed in financial markets?
In Finance in a Flat World: International Bonds on page 280, we learned about the bonds issued in financial markets outside of the United States. What are the potential benefits and costs of investing in foreign-issue bonds?
Distinguish between public and private corporate debt.
What is a floating-rate bond?
What is the difference between a bond's clean price and its dirty price, and what does the saying "buy clean, pay dirty" mean?
Describe the relationship between yield to maturity and the value of a bond.
In Finance for Life: Adjustable-Rate Mortgages on page 263, we learned the difference between fixed- and adjustable-rate mortgages. Why would you ever want to use an adjustable-rate mortgage (ARM)?
Distinguish among a bond's coupon interest rate, current yield, and yield to maturity.
The Bensington Glass Company entered into a loan agreement with the firm's bank to finance the firm's working capital. The loan called for a floating interest rate that was 30 basis points (.30 percent) over an index based on LIBOR. In addition, the loan adjusted weekly based on the closing value
Because preferred stock dividends must be paid before common stock dividends, should preferred stock be considered a liability and appear on the right side of the balance sheet alongside of the firm's long-term debt?
Herd Mentality on page 303, we learned that it is common for investors to follow the investment lead of others. If they are all investing in dotcom firms or biotech firms, you might be swayed to jump on the bandwagon and do the same. How might the media help reinforce herd behavior?
The market's required yield on preferred stock is actually a promised rate of return. Explain this statement.
The opening vignette on page 301 described Google first going public in 2004. Prior to going public, did Google's stock have a market price? What principles would go into determining the value of a company that hadn't gone public yet?
Tyrion L.'s Gadgets Inc. is trying to decide whether to cut its expected dividends for next year from $8 per share to $5 per share in order to have more money to invest in new projects. If it does not cut the dividend, the firm's expected rate of growth in dividends will be 5 percent per year, and
J. Pinkman Motors, Inc., paid a $3.75 dividend last year. If J. Pinkman's return on equity is 24 percent and its retention rate is 25 percent, what is the value of the common stock if the investors require a 20 percent rate of return?
Walter White, Inc.'s return on equity is 13 percent, and management has plans to retain 20 percent of earnings for investment in the company. a. What will be the company's growth rate? b. How would the growth rate change if management (i) increased retained earnings to 35 percent or (ii) decreased
Making Personal Investment Decisions on page 330, what were the types of personal decisions discussed that can be addressed using capital-budgeting analyses?
What is the rationale for using the MIRR as opposed to the IRR decision criterion? Describe the fundamental shortcoming of the MIRR method.
Higher Education as an Investment in Yourself on page 352, the decision to get a college education was discussed in the context of an investment decision. Discuss the analogy in more detail by identifying the initial cash outlay(s) and the future benefits of your investment in higher education.
Under what conditions would the payback and discounted payback period methods produce identical results?
What are the most widely used methods for evaluating capital expenditure projects in practice?
Some analysts argue that the payback period criterion is actually a measure of project risk. What is the logic behind this belief?
Where do firms learn about new investment ideas, and what is the role of the financial analyst in determining what projects the firm should undertake?
It is customary to think about investment projects as falling into one of three groups: • Revenue-enhancing, • Cost-reducing, • Mandatory. Describe what each of these categories means, and give an example.
How is the presence or absence of product market competition that a firm faces related to the NPV of the firm's investment opportunities? What are the types of barriers to competition (market entry) that tend to preserve positive NPVs?
Why is the NPV generally considered to be the preferred method for evaluating new capital investment proposals? Describe the meaning of the NPV to a close relative who has no business background in terms they would understand.
What does it mean to say that two or more investment projects are mutually exclusive? Discuss.
What are the limitations of the payback period as an investment decision criterion? What are its advantages? Why do you think it is used so frequently?
If a project's payback period is less than the maximum payback period that the firm will accept, does this mean that the project's NPV will also be positive?
The Merriweather Printing Company is trying to decide on the merits of constructing a new publishing facility. The project is expected to provide a series of positive cash flows for each of the next four years. The estimated cash flows associated with this project are as follows: Year
OTR Trucking runs a fleet of long-haul trucks and has recently expanded into the Midwest, where it has decided to build a maintenance facility.This project will require an initial cash outlay of $20 million and will generate annual cash inflows of $4.5 million per year for Years 1 through 3. In
What are the IRRs for the following projects? a. An initial outlay of $10,000 resulting in a single cash inflow of $17,182 in 8 years b. An initial outlay of $10,000 resulting in a single cash inflow of $48,077 in 10 years c. An initial outlay of $10,000 resulting in a single cash inflow of
Determine the IRRs for the following projects:a. An initial outlay of $10,000 resulting in a cash inflow of $1,993 at the end of each year for the next 10 yearsb. An initial outlay of $10,000 resulting in a cash inflow of $2,054 at the end of each year for the next 20 yearsc. An initial outlay of
As you saw in the introduction, the Toyota Prius took some of its sales away from other Toyota products. Toyota has also licensed its hybrid technology to Ford Motor Company, which allowed Ford to introduce a Ford Fusion hybrid in 2010 that traveled 39 miles per gallon (mpg), almost doubling the
Should overhead expense ever be considered when evaluating investment cash flows?
What are opportunity costs, and how should they affect an investment's cash flows? Give an example.
Should anticipated inflation be incorporated into project cash flow forecasts? If so, how?
When McDonald's moved into India, it faced a particularly difficult task. The major religion in India is the Hindu religion, and Hindus don't eat beef-in fact, most of the 1 billion people living in India are vegetarians. Still, McDonald's ventured into India and has been enormously successful. Why
For years, GM treated each car brand as if it were a separate company, considering all new car sales as incremental sales. Critically evaluate this position.
Throughout the examples in this chapter, we have assumed that the initial investment in working capital is later recaptured when the project ends. Is this a realistic assumption? Do firms always recover 100 percent of their investment in accounts receivable and inventories?
In Regardless of Your Major: The Internet on Airline Flights-Making It Happen on page 374, we described an investment proposal involving the sale of internet services on airlines. How would you approach the problem of calculating the cash flows for such a venture? What costs would you include in
Corporate overhead expenses related to utilities and other corporate expenses are generally not relevant to the analysis of new investment opportunities. Why?
New investments often require that the firm invest additional money in working capital. Give some examples of what this means.
When a firm finances a new investment, it often borrows part of the money, so the interest and principal payments this creates are incremental to the project's acceptance. Why are these expenditures not included in the project's cash flow computation?
Discuss how free cash flow differs from a firm's operating cash flow.
If depreciation is not a cash flow item, why does it affect the level of cash flows from a project?
Describe net operating working capital, and explain how changes in this quantity affect an investment proposal's cash flows.
What are sunk costs, and how should they be considered when evaluating an investment's cash flows?
Faraway Fabricators, Inc., is considering the expansion of its welding and stamping division and estimates that this will require the firm's accounts receivable to increase by 12 percent of the added sales. Moreover, Faraway estimates that inventories will be 15 percent of the added cost of goods
Killibrew Enterprises is considering a new project that is expected to generate added revenues $1,250,000 and incur added cash expenses (including both fixed and variable costs) of $650,000, while increasing depreciation by $200,000 per year. If the firm's tax rate is 34 percent, calculate the
As part of its planning for the coming Christmas season, Criswell Motorsports is considering whether to expand its product line that currently consists of skateboards to include gaspowered skateboards. The company feels it can sell 2,000 of these per year for 10 years (after which time this project
Marlin Manufacturing is considering whether to add new capacity to its production line with the addition of a $1 million assembly center. This purchase would result in an increase in earnings before interest and taxes of $400,000 per year. It would cost $50,000 after taxes to install the needed
The Carson Distribution Corporation, a firm in the 34 percent marginal tax bracket with a 15 percent required rate of return or discount rate, is considering a new project that involves the introduction of a new product. This project is expected to last five years, and then, because this is
Mark McNibble is CFO for McNabb Fabrications, Inc. Mark is considering a new project that involves the introduction of a new product. McNabb is in the 34 percent marginal tax bracket has a 15 percent required rate of return or discount rate for new investments. The new project is expected to last
On July 25, 2011, the average price of a gallon of gasoline was $3.70. Just five years later the price of that same gallon of gas was $2.14. What was the rate of inflation (deflation) in the price of a gallon of gas over the period?
After you reported your findings to Carlyle Chemicals' management (see Study Problem 12-28), the CFO suggested that the company could purchase raw materials in advance for future delivery. This would involve paying for the raw materials today and taking delivery as the materials are needed. Through
Aero Manufacturing Company is working on a new version of its tried-and-true wind-powered water pump. For 15 years, the firm had manufactured replacement parts for older-style windmills used on farms and ranches throughout the U.S. Southwest. However, the old-style pumps required the use of rods
Project Risk for Entrepreneurs on page 410 discussed the risks that entrepreneurs face, with about 40 percent of new businesses shutting their doors during their first year. If you had to pick a business to start, what would it be, and what type of risks might you face?
What is the objective of project risk analysis, and why is it critical to the investment decision-making process?
How do you perform a sensitivity analysis of an investment proposal, and what is its purpose? Contrast the use of scenario analysis with that of simulation analysis.
Currency Risk on page 422 discussed the currency risk that multinational firms face. Between July 2008 and December 2009, the value of the yen relative to the U.S. dollar went up by about 17 percent, and as a result, when companies traded dollars for yen, they got fewer dollars back. Which firms
The owner of the Petreno Pharmaceuticals Company is evaluating the expected annual sales for a new line of facial care products and estimates that there is a 60 percent chance that the product line will be extremely successful, in which case it will generate sales next year of $8 million. However,
Mayborn Enterprises, LLC runs a number of sporting goods businesses and is currently analyzing whether to start a new T-shirt printing business. Specifically, the company is evaluating the feasibility of this business based on its estimates of the unit sales, price per unit, variable cost per unit,
Last year Baker-Huggy, Inc. had sales of $500,000, fixed costs of $100,000 and net operating income (NOI) of $30,000. If sales increase by 20 percent, by how much will the firm's NOI increase? What would happen to the firm's NOI if sales decreased by 20 percent?
B&L, Inc.'s CFO anticipates that if the firm experiences a 10 percent increase in sales, its net operating profits will increase by 60 percent. If B&L's NOI is $15 million, what level of fixed costs does the firm have?
Koch Transportation is contemplating the acquisition of LH Transport, a competing trucking firm. Koch's CFO estimates that during the next year LH Transport's flows from the acquisition will vary depending on the state of the local economy:a. Calculate the expected cash flow for next year using the
Rao Roofing of Stillwater, Oklahoma, is also considering the acquisition of Simpkins Storage Company. Rao's management team has analyzed the annual cash flows for Simpkins and come up with these estimates for the three states of the economy:A rival firm, Mitchell Storage Company is also considering
Floating Homes, Inc., is a manufacturer of luxury pontoon and houseboats that sell for $40,000 to $100,000. To estimate its revenues for the following year, Floating Homes divides its boat sales into three categories based on selling price (high, medium, and low) and estimates the number of units
Managers at the Physicians' Bone and Joint (PB&J) Clinic are considering whether to purchase a newly developed MRI machine that the manufacturer tells them will provide the basis for better diagnoses of foot and knee problems. The new machine is quite expensive but should last for a number of
Blindfold Technologies Inc. (BTI) is considering whether to introduce a new line of hand scanners that can be used to copy material and then download it into a computer. These scanners are expected to sell for an average price of $100 each, and the company analysts performing the analysis expect
What is a firm's WACC?
Explain the rationale given for the differences we observe in interest rates among countries discussed in Finance in a Flat World: Why Do Interest Rates Differ Among Countries?
Figure 14.3 contains average yields to maturity for corporate bonds of differing maturities and default ratings. The yields are based on spreads to Treasury securities. Using the figure, what is the spread to Treasury for an A-rated corporate bond with a 10-year maturity? Bond spreads are typically
Describe the three-step process for estimating WACC.
What are the basic sources of financing included in a firm's capital structure? Specifically, what financing sources are excluded from the firm's capital structure when calculating firm WACC?
Looking back at Regardless of Your Major: Understanding the Role of the Cost of Capital on page 446, what should be the opportunity cost of funds in valuing the cash flows from the ownership of a McDonald's franchise? How would you respond to your friend after having read the entire chapter?
What are the pros and cons of using risk-adjusted costs of capital for individual investments?
Divisional WACCs are the most popular method used in practice to risk adjust the cost of capital. Describe how you might go about estimating divisional WACCs. What are the pros and cons of using divisional WACCs?
Companies that face large investments that they cannot finance internally through the retention of earnings must go to the financial markets to raise the needed funds. When they do this, they will incur what are commonly referred to as flotation costs. Discuss how these flotation costs should be
The financial crisis of 2007-2009 and the ensuing attempts by the Federal Reserve to stave off a deepening recession affected the cost of capital for all firms. Specifically, although very short-term Treasury bill rates were driven to near zero as investors sought the relative safety of
In the chapter introduction, we discussed the Starbucks (SBUX) acquisition of Seattle's Best Coffee Company in 2003. Discuss the relevance of Seattle's Best's WACC as the opportunity cost of funds that should be used in valuing the acquisition. What if Starbucks planned to finance the entire $72
The Shiloh Corporation is contemplating a new investment that it plans to finance using one-third debt. The firm can sell new $1,000 par value bonds with a 15-year maturity and a coupon interest rate of 13 percent (with interest paid semiannually) at a price of $950. If the company is in a 34
In the spring of 2017 the Marrion Metal Shaping Company was planning on issuing preferred stock to help finance a major plant expansion. The stock is expected to sell for $98 a share and will have a $100 par value on which the firm will pay a 10 percent dividend. What is the cost of capital to

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