Questions and Answers of Corporate Finance Principles And Practice

Jay Ritter invested $1,000 in the stock of the SDH Company. The company pays a current dividend of $2, which is expected to grow by 20 percent per year for the next two years. What will the dividend
Fernando Zapetero, who recently won $20,000 in the lottery, wants to buy a car in five years. Fernando estimates that the car will cost $32,210 at that time. His cash flows are displayed in Figure
Bernard Dumas will receive $10,000 three years from now. Bernard can earn 8 percent on his investments, so the appropriate discount rate is 8 percent. What is the present value of his future cash
U.S. Secretary of State William Seward negotiated the purchase of Alaska from Russia in 1867. The United States paid $7.2 million in exchange for 586,412 square miles of new land. Opponents of the
Paige Ouimet wants to buy a tugboat today. Rather than paying immediately, she offers to pay $150,000 in three years. It will cost Tugboat Corp. $115,830 to build the tugboat immediately. The
You’ve been saving up to buy the Godot Company. The total cost will be $10 million. You currently have about $2.3 million. If you can earn 5 percent on your money, how long will you have to wait?
Kyle Mayer won the Kentucky State Lottery and will receive the following set of cash flows over the next two years:Kyle can currently earn 6 percent in his money market account, so the appropriate
Finance.com has an opportunity to invest in a new high-speed computer that costs $50,000. The computer will generate cash flows of $25,000 one year from now, $20,000 two years from now, and $15,000
Compute the future value of $4,250 continuously compounded for:a. 9 years at an APR of 12 percent.b. 5 years at an APR of 8 percent.c. 17 years at an APR of 5 percent.d. 10 years at an APR of 9
If an 8 percent annual percentage rate is compounded quarterly, what is the effective annual rate?Using Equation 4.7, we have:Referring back to our original example where C0 = $1,000 and r = 10%, we
Harry DeAngelo is investing $5,000 at an annual percentage rate of 12 percent per year, compounded quarterly, for five years. What is his wealth at the end of five years?Using Equation 4.8, his
The Perpetual Life Insurance Co. is trying to sell you an investment policy that will pay you and your heirs $20,000 per year forever. If the required return on this investment is 3.4 percent, how
Katharina Lewellen invested $1,000 at a continuously compounded rate of 10 percent for one year. What is the value of her wealth at the end of one year? From Equation 4.9 we have:This number can
Katharina’s husband, Jonathan, invested $1,000 at a continuously compounded rate of 10 percent for two years. The appropriate formula here is:Using the portion of the table of continuously
The Michigan State Lottery is going to pay you $100,000 at the end of four years. If the annual continuously compounded rate of interest is 8 percent, what is the present value of this payment?
Consider a perpetuity paying $100 a year. If the relevant discount rate is 8 percent, what is the value of the perpetuity today? Using Equation 4.10 we have:Now suppose that the discount rate falls
Popovich Corporation is about to pay a dividend of $3.00 per share. Investors anticipate that the annual dividend will rise by 6 percent a year forever. The applicable discount rate is 11 percent.
Danielle Caravello will receive a four-year annuity of $500 per year, with the first payment at Year 6. If the discount rate is 10 percent, what is the value of her annuity today? The timeline for
Harold and Helen Nash are saving for the college education of their newborn daughter, Susan. The Nashes estimate that college expenses will run $30,000 per year when their daughter reaches college in
Mark Young has won the state lottery, paying $50,000 a year for 20 years. He is to receive his first payment a year from now. The state advertises this as the Million Dollar Lottery because
Suppose you put $3,000 per year into a Roth IRA. The account earns 6 percent interest per year. How much will you have when you retire in 30 years? This question asks for the future value of an
Ann Chen receives an annuity of $450, payable once every two years. The annuity stretches out over 20 years. The first payment occurs at Year 2—that is, two years from today. The annual discount
Mark Weinstein has been working on an advanced technology in laser eye surgery. His technology will be available in the near term. He anticipates his first annual cash flow from the technology to be
In a previous example, Helen and Harold Nash planned to make 17 identical payments to fund the college education of their daughter, Susan. Alternatively, imagine that they planned to increase their
A common arrangement in real estate lending might call for a 5-year loan with, say, a 15-year amortization. What this means is that the borrower makes a payment every month of a fixed amount based on
A prestigious investment bank designed a new security that pays a quarterly dividend of $2.50 in perpetuity. The first dividend occurs one quarter from today. What is the price of the security if the
The Trojan Pizza Company is contemplating investing $1 million in four new outlets in Los Angeles. Andrew Lo, the firm’s chief financial officer (CFO), has estimated that the investments will pay
M3 Pharmaceuticals is considering a drug project that costs $5.95 million today and is expected to generate end-of-year annual cash flows of $560,000 forever. At what discount rate would the company
Southern California Publishing Company is trying to decide whether to revise its popular textbook Financial Psychoanalysis Made Simple. The company has estimated that the revision will cost $325,000.
A five-year annuity of 10 $5,500 semiannual payments will begin nine years from now, with the first payment coming nine and a half years from now. If the discount rate is 8 percent compounded
You are saving for the college education of your two children. They are two years apart in age; one will begin college 15 years from today and the other will begin 17 years from today. You estimate
You want to lease a set of golf clubs from Pings Ltd. The lease contract is in the form of 24 equal monthly payments at an APR of 10.4 percent compounded monthly. Because the clubs cost $3,850
What is the value of an investment that pays $75,000 every other year forever, if the first payment occurs one year from today and the discount rate is a 7 percent APR compounded daily? What is the
Stanley Jaffe and Sherry Lansing have purchased the rights to Corporate Finance: The Motion Picture. They will produce this major motion picture on either a small budget or a large budget. Here are
The Alpha Corporation is considering investing in a riskless project costing $100. The project receives $107 in one year and has no other cash flows. The discount rate on riskless investments is 2
A useful rule of thumb for the time it takes an investment to double with discrete compounding is the “Rule of 72.” To use the Rule of 72, you divide 72 by the rate to determine the number of
Suppose that the Kaufold Corporation has two alternative uses for a warehouse. It can store toxic waste containers (Project A) or electronic equipment (Project B). The cash flows are as follows:We
Hiram Finnegan, Inc. (HFI), applies a 12 percent discount rate to two investment opportunities. Project 12 2 Cash Flows (in millions) C₁ $70 15 Co - $20 - 10 C₂ $10 40 PV @12% of Cash Flows
The Utah Mining Corporation is set to open a gold mine near Provo, Utah. According to the treasurer, Monty Goldstein, “This is a golden opportunity.” The mine will cost $3.8 million to open and
The Weber-Decker Co. just paid $1 million in cash for a building as part of a new capital budgeting project. This entire $1 million is an immediate cash outflow. However, assuming straight-line
The General Milk Company (GMC) is currently evaluating the NPV of establishing a line of chocolate milk. As part of the evaluation, the company paid a consulting firm $100,000 last year for a test
Suppose the Stiles Trading Company has an empty warehouse in Philadelphia that can be used to store a new line of electronic pinball machines. The company hopes to sell these machines to affluent
Your company currently produces and sells steel shaft golf clubs. The board of directors wants you to consider the introduction of a new line of titanium bubble woods with graphite shafts. Which of
Suppose the Innovative Motors Corporation (IMC) is determining the NPV of a new convertible sports car. Some of the would-be purchasers are owners of IMC’s compact sedans.Are all cash flows from
We are considering the purchase of a $200,000 computer-based inventory management system. It will be depreciated straight-line to zero over its four-year life. It will be worth $30,000 at the end of
The Voetmann Consulting Corp. devotes one wing of its suite of offices to a library requiring a cash outflow of $100,000 a year in upkeep. A proposed capital budgeting project is expected to generate
The little-known monarchy of Gerberovia recently had a nominal interest rate of 300 percent and an inflation rate of 280 percent. According to Equation 6.7, the real interest rate is:How do we know
Burrows Publishing has purchased the rights to the next book of famed romantic novelist Barbara Musk. Still unwritten, the book should be available to the public in four years. Currently, romantic
Altshuler, Inc., generated the following forecast for a capital budgeting project:The CEO, David Altshuler, estimates inflation to be 10 percent per year over the next two years.In addition, he
Shields Electric forecasts the following nominal cash flows on a particular project:The nominal discount rate is 14 percent, and the inflation rate is forecast to be 5 percent. What is the value of
EOBII Publishers, a competitor of Burrows, recently bought a printing press for $2,000,000 to be depreciated to zero by the straight-line method over five years. This implies yearly depreciation of
A major college textbook publisher has an existing finance textbook. The publisher is debating whether to produce an “essentialized” version, meaning a shorter (and lower-priced) book. What are
Medavoy Co. is considering a new project that complements its existing business. The machine required for the project costs $3.7 million. The marketing department predicts that sales related to the
In evaluating the Cayenne, what do you think Porsche needs to assume regarding the substantial profit margins that exist in this market? Do you think they were able to maintain this profit margin as
Sparkling Water, Inc., expects to sell 3.8 million bottles of drinking water each year in perpetuity. This year each bottle will sell for $1.52 in real terms and will cost $.87 in real terms. Sales
Shado, Inc., is considering an investment of $750,000 in an asset with an economic life of five years. The firm estimates that the nominal annual cash revenues and expenses at the end of the first
A firm is considering an investment in a new machine with a price of $10.9 million to replace its existing machine. The current machine has a book value of $3.8 million and a market value of $2.8
With the growing popularity of casual surf print clothing, two recent MBA graduates decided to broaden this casual surf concept to encompass a “surf lifestyle for the home.” With limited capital,
Calligraphy Pens is deciding when to replace its old machine. The machine’s current salvage value is $2.8 million. Its current book value is $1.6 million. If not sold, the old machine will require
Kopperud Electronics has an investment opportunity to produce a new HDTV. The required investment on January 1 of this year is $125 million.The firm will depreciate the investment to zero using the
Suppose we are thinking about replacing an old computer with a new one. The old one cost us $1.4 million; the new one will cost $1.7 million. The new machine will be depreciated straight-line to zero
After extensive medical and marketing research, Pill, Inc., believes it can penetrate the pain reliever market. It is considering two alternative products.The first is a medication for headache pain.
It is 15 December, and a company wants to borrow £2m, for a period of three months, in three months’ time. The three-month LIBOR rate stands at 6 per cent and the company wants to guard against an
Yell plc wants to find the relative importance of the determinants of its cost of equity, namely the risk-free rate of return, business risk and financial risk. You have the following information:1.
Arclight plc, a company producing high-quality household lighting products, is considering diversifying into the furniture business. The project has an expected return of 15 per cent. Arclight plc
PXP plc is a listed company that has made an offer of £3.20 per share for the ordinary share capital of VVM plc. Details of the two companies are as follows:PXP is not sure whether to finance the
A company has in issue a 10 per cent bond, redeemable at the option of the company between one and five years from now. What factors will be considered by the company in reaching a decision on when
Three investment projects, A, B and C, have the following net cash flows. Decide which of them should be accepted using the NPV decision rule if the discount rate is 12 per cent.
Why is payback commonly used as a way of dealing with risk in investment projects?
Discuss the use of risk-adjusted discount rates in evaluating investment projects.
Explain the meaning of ‘simulation’ in the context of investment appraisal.
How do foreign direct investment decisions differ from domestic investment decisions?
The shares of companies Z and Y have the following expected returns and standard deviations: If the correlation coefficient between the two securities is +0.25, calculate the expected return and
Discuss whether all companies use the same investment appraisal methods.
The global financial crisis of 2008, followed by the Covid-19 pandemic, has made fundamental changes to the way financial markets work. Interventions by central banks, designed to save economies from
Explain why risk continues to exist even in a well-diversified portfolio.
Nobel-prize winning economist Harry Markowitz wrote that ‘diversification is the only free lunch in finance’. A free lunch sounds good, but the reality is often bland sandwiches, a plate of
Discuss whether diversification at company level has any value to a company’s ordinary shareholders.
You are looking to invest in two shares, X and Y, and have the following information:(a) Calculate the expected return for each share and for a portfolio of 60 per cent X and 40 per cent Y. (b)
Distinguish between an efficient portfolio and an optimal portfolio.
The US equity risk premium, the extra return investors can expect for buying US stocks instead of riskfree government bonds, has fallen to its lowest levels of the past decade by some measures, as
Rosenior plc has been investing surplus funds in a small portfolio of shares over the past few years. Details of the portfolio are as follows:The current market return is 12 per cent and the yield on
Value investing, defined as buying or selling securities at prices different than their true value, is alive and well. You might not know that by reading headlines in the financial press or
Explain the importance of risk-free assets to portfolio theory.
How do we approximate the risk-free rate in practice? In reality, will the capital market line be a straight line?
List the limitations of portfolio theory as an aid to investment decisions.
Explain whether you consider the assumptions upon which the capital asset pricing model is based to be unrealistic.
Explain what is measured by beta.
Identify the problems associated with determining the equity risk premium.
The market return is 10 per cent and UK Treasury bills yield 4 per cent. Lime Spider plc shares have a covariance of 7.5 with the market whereas the market has a variance of 4.5. What is the required
Ofwat has turned the screw on water industry operators across England and Wales by demanding they accept lower rates of return on equity and capital in the next five-year regulatory period that runs
Gorky has in issue 500,000 £1 ordinary shares whose current ex dividend market price is £1.50 per share. The company has just paid a dividend of 27p per share and dividends are expected to continue
Calet plc pays corporation tax at 19 per cent and has the following capital structure: – Ordinary shares: 1,000,000 ordinary shares of nominal value 25p per share and market value of 79p per share.
You are given the following financial position statement information about Jordan plc: Non-current assets Current assets Total assets Equity finance Ordinary shares (50p nominal
Strummer plc is calculating its current weighted average cost of capital on both a book value and a market value basis. You have the following information:1. The current dividend, shortly to be paid,
At one point in February 2020, a single cruise ship – the Diamond Princess – accounted for more than half of the world’s confirmed cases of Covid-19 outside China. The 3,700 passengers and crew
The following information has been taken from the accounts of Merlin plc: (i) The current ex div ordinary share price of Merlin plc is £3.14. Both dividends and share price are expected to increase
The 8 per cent irredeemable bonds of Eranio plc are currently trading at £92 per £100 bond. If the company pays corporation tax of 19 per cent, what is the current after-tax cost of debt of the
Two companies, A and B, have similar net operating incomes (i.e. gross income less operating expenses) and similar levels of business risk. The only difference is that Company A is not geared,
Pollock has in issue 1 million ordinary shares, nominal value 25p and £100,000 of 8 per cent irredeemable bonds. The current ex dividend market price of the ordinary shares is 49p per share and the

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