Questions and Answers of Corporate Finance 5th Edition

Since the financial crisis, investors have become increasingly vocal about the size of executive pay and many companies have seen remuneration packages refused by shareholders at annual general
Finance executives need to know and understand the corporate governance environment in which they operate.1. Visit the European Corporate Governance Institute website (www.ecgi.org) and download the
What does the term ‘window dressing’ mean in the context of financial statements? Identify three window-dressing techniques that companies use. What implications does this have for cash flows in
Explain the difference between book value and market value. Under standard accounting rules, it is possible for a company’s liabilities to exceed its assets. When this occurs, the owners’ equity
Identify two circumstances where negative operating cash flow might not necessarily be a sign of deteriorating financial health. When can negative operating cash flow become problematic for a company?
A financial ratio by itself tells us little about a company because financial ratios vary a great deal across industries. There are two basic methods for analysing financial ratios for a company:
Both ROA and ROE measure profitability. What does each of them measure, and which one is more useful for comparing two companies? Why?
According to AEB Systems plc financial statements as of June 2015, the firm had current assets of £6.642 billion, non-current assets of £16.521 billion, current liabilities of £11.283 billion, and
In 2015, the UK insurance firm, Wheeler & Fox, had revenue of £38,440 million, total expenses of £37,133 million, tax of £487 million and zero depreciation. What is the net income for the firm?
In 2015, the Swedish bank, Nordicbank, had a price–earnings ratio of 6.35. If the firm’s share price was SKr71.70, what was its earnings per share?
Your company has just sealed a deal to sell a tract of land with accompanying warehouse for €3.2 million. This is significantly lower than the €7 million your firm paid when the plot was
A firm has net revenues of £6,065 million (including net non-cash expenses). Net non-cash expenses (including depreciation) were £2,380 million. Cash outflows from investing activities (including
Morena’s Driving School’s 2015 statement of financial position showed non-current assets of £4.2 million. One year later, the 2016 statement of financial position showed non-current assets of
The following table presents the long-term debt and shareholders’ equity of Tumbler SA one year ago:During the past year, Tumbler issued 20 million shares at a total price of €52 million, and
Find the annual income statements and statement of financial positions for two firms in the same industry from your own country. Calculate the Du Pont identity for each company for the most recent 3
Firm A and Firm B have debt–total asset ratios of 70 per cent and 30 per cent, and returns on total assets of 20 per cent and 30 per cent, respectively. Which firm has a greater return on equity?
As of December 2014, the Royal Bank of Scotland plc made a net loss of £3.47 billion on revenues of £18.197 billion. What was the company’s profit margin? Does the fact that these figures are
For the year ending 2015, TJC plc has revenues of £1,027 million and total costs (excluding interest) of £817 million. Net interest expense was £29 million and depreciation was £12 million. What
A company has net income of €173,000, a profit margin of 8.6 per cent, and a trade receivables balance of €143,200. Assuming 75 per cent of sales are on credit, what is the company’s days’
Le Verd SA has a ratio of long-term debt to total assets of 0.70 and a current ratio of 1.20. Current liabilities are £850, revenues are £4,310, profit margin is 9.5 per cent, and ROE is 21.5 per
Titan SpA’s net income for the most recent year was €4,850. The tax rate was 33 per cent. The firm paid €2,108 in total interest expense and deducted €1,687 in depreciation expense. What was
Guthrie plc has current liabilities of £340,000, a quick ratio of 1.8, inventory turnover of 4.2 and a current ratio of 3.3. What is the cost of goods sold for the company?
Calculate all relevant financial ratios for Sement AG. Revenue Cost of goods sold Operating income Less: Depreciation Summarized Statement of Income 77,327 56,284 21,043 Other expenses Income from
What are the weaknesses in the Sement examples for interpreting its financial well-being? Explain.
Lewellen (2004) makes a strong case for why financial ratios, such as dividend yield, book-to-market ratio and earnings per share, will predict prices. Discuss this argument and his main findings to
Rountree et al. (2008) show that investors do not like cash flow volatility. Consider the financial ratios presented in this chapter. Can you adapt an existing financial ratio or construct a new one
Earnings per share What is the earnings per share for each year between 2012 and 2015 for Montgomery Organizations plc? What is your interpretation of these figures? Is EPS a reliable measure of
What is the effective tax rate for Montgomery Organizations plc for each year?Montgomery Organizations plc, whose annual accounts are given below. The firm has 14,685,856 shares and the share price
What is the net working capital of Montgomery Organizations plc in each year? What is the cause of the figures? Is this a healthy situation for the firm? Explain.Montgomery Organizations plc, whose
Construct common-size statements for Montgomery Organizations plc.Montgomery Organizations plc, whose annual accounts are given below. The firm has 14,685,856 shares and the share price is £2.78.
Liquidity How would you rate the liquidity position of Montgomery Organizations plc between 2012 and 2015? Provide a brief report of the company’s liquidity over time.Montgomery Organizations plc,
How would you rate the long-term solvency position of Montgomery Organizations plc between 2012 and 2015? Provide a brief report of the company’s long-term solvency over time.Montgomery
How efficient have Montgomery Organizations plc’s operations been during 2015? Provide a brief report of the company’s asset efficiency over time.Montgomery Organizations plc, whose annual
What is the profitability of Montgomery Organizations plc like over the period 2012 and 2015? Provide a brief report of the company’s profitability over time. Do profitability ratios give a good
Provide an overview on the company’s relative market valuation over the period 2012–2015. What can be inferred from the company’s relative market valuation?Montgomery Organizations plc, whose
Undertake a full Du Pont Identity analysis for the year 2015 to provide insights into the drivers of its return on equity.Montgomery Organizations plc, whose annual accounts are given below. The
Discuss the advantages and disadvantages of ratio analysis.Montgomery Organizations plc, whose annual accounts are given below. The firm has 14,685,856 shares and the share price is £2.78. Fixed
You are tasked with analysing the last 2 years of accounts of a global mining firm. A simplified statement of financial position and income statement are provided below.1. Using the information
Dan Ervin was recently hired by West Coast Yachts Ltd to assist the company with its shortterm financial planning and also to evaluate the company’s financial performance. Dan graduated from
Valuation: The One-period Case Your friend tells you that it does not matter when you receive money, since it is always worth the same. He tells you that £100 today is worth the same as £100
Valuation: The Multi-period Case You have taken out a loan that requires annual payments of £110 for each of the next 2 years. You wish to pay back the loan over 4 years. Should the payment be £55
Compounding Periods As you increase the length of time involved, what happens to future values? What happens to present values? What happens to the future value of an annuity if you increase the rate
Simplifications Can the simplified formulae provided in this chapter work for every valuation problem? Explain your answer with an illustration.
What is a Firm Worth? What is discounted cash flow (DCF) valuation? Can it be used to estimate the value of companies? What businesses could we value using DCF valuation?What are the advantages and
Interest You work for a jewellers and have sourced a good goldsmith who is able to sell you 100 ounces of gold for £100,000. You approach your two main customers. Mr Noel says he will buy the gold
Calculating Future Values Calculate the future value of a £100 cash flow for the following combinations of rates and times:(a) r = 8%; t = 10 years(b) r = 8%; t = 20 years(c) r = 4%; t = 10 years(d)
Calculating Future Values If you invest €1,000 in a savings account that pays 4 per cent every year, how long would it take you to triple your money?
Calculating Present Values Calculate the present value of a £100 cash flow for the following rates and times:(a) r = 8%; t = 10 years(b) r = 8%; t = 20 years (c) r = 4%; t = 10 years (d) r = 4%; t =
Calculating Rates of Return You own a property on the Isle of Arran, which you estimate will provide an annual income of £10,000 per year in perpetuity. If the property is valued at£250,000, what
Calculating Rates of Return On 8 February 2009, John Madejski, chairman of Reading Football Club, sold the Edgar Degas bronze sculpture Petite Danseuse de Quartorze Ans at auction for a world record
Perpetuities An investor purchasing a British consol is entitled to receive annual payments from the British government forever. What is the price of a consol that pays £4 annually if the next
Continuous Compounding A zero coupon bond that will pay €1,000 in 10 years is selling today at €422.41. What is the continuously compounded annual interest rate on the bond?
Net Present Value Your company has the opportunity to invest in a new computer system that requires an initial outlay of €20,000, and will increase the firm’s cash flows by €4,000 per year for
Calculating Annuity Present Value An investment offers €4,000 per year for 10 years, with the first payment occurring one year from now. If the required return is 9 per cent, what is the value of
Calculating APR Find the APR for the following 5-year loan: A principal of £15,000 with a stated annual interest rate of 7 per cent on the original principal amount to be paid in 60 monthly
Present Value A 25-year fixed-rate mortgage has monthly payments of €717 per month and a mortgage interest rate of 6.14 per cent per year compounded monthly. If a buyer purchases a home with the
Future Value What is the future value in 4 years of €1,000 invested in an account with a stated annual interest rate of 10 per cent,(a) Compounded annually(b) Compounded semi-annually(c) Compounded
Calculating Annuities You are planning to save for retirement over the next 30 years. To do this, you will invest £500 a month in a share account and £500 a month in a bond account. The return of
Compounding What is the annualized interest rate, compounded daily, that is equivalent to 12 per cent interest compounded semi-annually? What is the daily compounded rate that is equivalent to 12 per
Growing Perpetuities Oasis Telephony has been working on a new hands-free telephone that clips into your ear. The new gadget has now been cleared for manufacture and development. Oasis Telephony
Unusual Perpetuities You have invested in a project that will pay you £1,000 every 2 years. If the interest rate is 8 per cent, how much is the project worth today?
Balloon Payments Mario Guiglini has just sold his hotel and purchased a restaurant with the proceeds. The restaurant is on the Riccione seafront in northern Italy. The cost of the restaurant to Mario
Calculating Interest Expense You receive a credit card application from Shady Banks plc offering an introductory rate of 1.90 per cent per year, compounded monthly for the first 6 months, increasing
Growing Annuity Your job pays you only once a year for all the work you did over the previous 12 months. Today, 31 December, you just received your salary of £100,000, and plan to spend all of it.
Calculating APR A local finance company quotes a 14 per cent interest rate on one-year loans. So, if you borrow €20,000, the interest for the year will be €2,800. Because you must repay a total
Calculating Present Values A 3-year annuity of six £5,000 semi-annual payments will begin 10 years from now, with the first payment coming 10.5 years from now. If the discount rate is 10 per cent
Calculating Annuities Due You want to lease a set of golf clubs from Pings Ltd. The lease contract is in the form of 36 equal monthly payments at a 14 per cent stated annual interest rate, compounded
Annuities A couple will retire in 50 years; they plan to spend about £30,000 a year in retirement, which should last about 25 years. They believe that they can earn 8 per cent interest on retirement
Balloon Payments On 1 September 2012, Susan Chao bought a motorcycle for £15,000.She paid £1,000 down and financed the balance with a 5-year loan at a stated annual interest rate of 9.6 per cent,
Calculating Annuity Values You are serving on a jury. A plaintiff is suing the city for injuries sustained after a freak doggie poo accident. In the trial, doctors testified that it will be 5 years
Annuities You have just read a life-enhancing book that tells you that if you believe things will happen, they will! You decide that you want to become a millionaire by the time you are 65. You have
Ordinary Annuities and Annuities Due As discussed in the text, an annuity due is identical to an ordinary annuity except that the periodic payments occur at the beginning of each period and not at
Rule of 72 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 simply divide 72 by the interest rate to
1. You have just started a new company to deliver mail and parcels to rural communities. At the moment, other companies either do not provide a service or are exceptionally expensive. The new company
Max Gruber graduated from university 6 years ago with a finance undergraduate degree.Although he is satisfied with his current job, his goal is to become an investment banker. He feels that an MBA
1. In Yahoo! Finance, find the closing price for a company in your country. Find the price exactly 4 years before. What was your annual return over the last 4 years assuming you purchased the equity
Using one-half of the most recent cash and cash equivalents reported on the balance sheet (in thousands of dollars), compute the following:a. The number of shares that would be repurchased given the
Perform a sensitivity analysis by varying the project forecasts as follows:a. Suppose first year sales will equal 2%–4% of IBM’s revenues.b. Suppose the cost of capital is 10%–15%.c. Suppose
Why does the CAPM imply that investors should trade very rarely?
Based on your analysis, do the debt increase and stock repurchase appear to be a good idea? Why or why not? What issues might the executives of Home Depot raise that aren’t considered in your
Under which program would your client be better off before taxes? Which program is better after taxes, assuming the remaining shares are sold immediately after the dividend is paid?
What was the effective dividend tax rate for a U.S. investor in the highest tax bracket who planned to hold a stock for one year in 1981? How did the effective dividend tax rate change in 1982 when
The dividend tax cut passed in 2003 lowered the effective dividend tax rate for a U.S. investor in the highest tax bracket to a historic low. During which other periods in the last 35 years was the
Compare the results under the three methods and explain how the resulting NPVs are achieved under each of the three different methods.
Revtek, Inc., has an equity cost of capital of 12% and a debt cost of capital of 6%. Revtek maintains a constant debt-equity ratio of 0.5, and its tax rate is 25%.What is Revtek’s WACC given its
In percentage terms, how much would the stated level of the indebtedness of the State of Florida increase if the level of underfunding in the state’s pension plan is included in overall state
Consider two investment projects, both of which require an upfront investment of $10 million and pay a constant positive amount each year for the next 10 years. Under what conditions can you rank
Using the three financial statements, calculate the five-year historical average for Columbia’s Return on
Compare the stock prices from the two methods to the actual stock price. What recommendations can you make as to whether clients should buy or sell Columbia stock based on your price estimates?
Explain to your boss why the estimates from the two valuation methods differ. Specifically, address the assumptions implicit in the models themselves as well as those you made in preparing your
DFB, Inc., expects earnings at the end of this year of $5 per share, and it plans to pay a $3 dividend at that time. DFB will retain $2 per share of its earnings to reinvest in new projects with an
Alphabet (GOOGL) has yet to pay a dividend, but in spring 2018 it announced it would repurchase $8.5 billion worth of shares over the year. (Actually, the exact amount was $8,589,869,056—known as a
What do you notice about the average of the volatilities of the individual stocks, compared to the volatility of the equally weighted portfolio?
Suppose Best Buy stock is trading for $30 per share for a total market cap of $9 billion, and Walt Disney has 1.65 billion shares outstanding. If you hold the market portfolio, and as part of it hold
Assume the risk-free rate is 4%. You are a financial advisor, and must choose one of the funds below to recommend to each of your clients. Whichever fund you recommend, your clients will then combine
Suppose that in place of the S&P 500, you wanted to use a broader market portfolio of all U.S. stocks and bonds as the market proxy. Could you use the same estimate for the market risk premium
Suppose that all investors have the disposition effect. A new stock has just been issued at a price of $50, so all investors in this stock purchased the stock today. A year from now the stock will be
To put the turnover of Figure 13.3 into perspective, let’s do a back of the envelope calculation of what an investor’s average turnover per stock would be were he to follow a policy of investing
Davita Spencer is a manager at Half Dome Asset Management. She can generate an alpha of 2% a year up to $100 million. After that her skills are spread too thin, so cannot add value and her alpha is
Assume the economy consisted of three types of people. 50% are fad followers, 45% are passive investors (they have read this book and so hold the market portfolio), and 5% are informed traders. The

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